Writedowns
What are they?
Writedowns are the amount of money by which banks have to reduce the value of assets held on their balance sheets in order to match the value of those assets if they were sold at current market prices.
For example, if Very Large Bank A were to buy a portfolio of asset backed securities valued at $5m, all things being equal it would show an additional $5m of assets next time it presented its quarterly accounts.
However, if, three months later, someone sells a similar portfolio of assets for $3.5m, the bank would be forced to write down the value of its ABS portfolio by $1.5m to match current market prices.
Writedowns are related to mark to market accounting. At the start of the crisis, even if a bank had no intention of selling its assets, it still had to value them according to how much it could sell them for at that moment in time. And because the price of the assets was set by the most recent fire (ie, desperate) sale, it was often much lower than the price the bank had given its assets previously.
Understandably, mark to market accounting procedures were accused of making the crisis worse. European accounting rules were therefore changed in late 2008 to allow European banks to stop marking to market and to value assets at a price they could theoretically sell them for in the future. This helped to reduce writedowns at institutions like Deutsche Bank in the third quarter of the year.
What have they got to do with the financial crisis?
Thanks to the fact that financial products like mortgage backed securities, and CDOs have now become virtually impossible to sell, banks had to reduce the value attributed to these products on their balance sheets by huge amounts.
How huge? Calculations of writedowns vary depending upon who you ask. In April 2009, the International Monetary Fund estimated that banks had racked up $4.1 trillion in writedowns. And there are probably trillions more to come. Those writedowns, may lead banks to a total of $470 billion in losses, Moody's said, which would cleanly wipe out their gains during the boom times. The writedowns and losses stand to increase because of hidden junk assets that have yet to see the light of day.
Part of the problem was that banks were not forced to sell all their MBS and CDOs on the open market, which was almost totally frozen for months. As a result, most writedowns were instead made according to an index provided by UK company Markit.
The few banks that did sell some assets received a big shock. In July 2008, for example, Merrill Lynch sold $30.6bn of CDOs for just $6.7bn - or just 22 cents on the dollar.
Writedowns are a big issue, because as the value of their assets fall, banks a) have to raise new assets, and b) are unable to take on new liabilities. The first point means they've gone looking for cash injections from overseas (with China and the Middle East among their favourite destinations). The second point means they're unwilling to make new loans and extend credit - either to each other or to anyone else. Hence the crunch.
With no end to writedowns in sight, banks instead successfully lobbied lawmakers to change the accounting rules to reduce the carnage.
Last updated on 7 September 2009.
