PRICE THE STOCK BY THE FLOW?

On both sides of the Atlantic Cable that first tied UK and USA financial markets and stock exchanges and then Continental Europe's too, that today has somehow determined that systemically important banks (economically vital), from that of Fifth Third Bancorp to Lloyds Banking Group, to Royal Bank of Scotland, Unicredit, Fortis, and others, the banks' share prices are the price of postal stamps and bank capitalisation is a mere fraction of book value; in effect the shares are more like 'options' and the actual 'options' must therefore be the best market bets going, so good in fact that short-sellers like UK hedge fund Odey (up 42.5% in $ terms last year) is now going long on such banks. Maybe they are anticipating a change about to be permitted to mark-to-market pricing standards, something probabilistically determined using the forward-looking dimensions of the new accounting standard IFRS7?
What does marking assets to market prices mean. It means pricing the stock far below the valuation that can be justified by net income to the asset just as in the case of major banks. For example, the prices of assets on the books of Washington Mutual, when it was bought by J.P. Morgan at a fire-sale price, were cited as a reason to mark-down the assets on the books of Wachovia. This, some say, forced the FDIC /Federal Deposit Insurance Corporation) to arrange Wachovia´s sale to Citibank even though these banks are cash-flow positive. Similarly,Fannie Mae and Freddie Mac, had positive cash flow when they were nationalized by the US Treasury. Fannie Mae and Freddie Mac have not yet actually had to draw down a dime from the Treasury's $200 billion facility that was created to bail them out. It was the use of mark-to-market accounting that allowed Treasury to declare them bankrupt when on a cash flow basis, they are solvent. Mark-to-market accounting causes mayhem for tried and tested accounting standards reasons, but with the awkward and often devastating proviso that financial firms are forced to treat all potential losses as if they were current cash losses, and indeed this is how the general public, including many shareholders, perceives all loss announcements. Even if the firm does not sell at the excessively low price, and even if the net present value of current cash flows of these assets is above the market price, the firm must run the loss through its capital account and into its P/L bottom line statement for loss provision, hitting dividends and tax provision. If the loss is large enough, then the firm can find itself in violation of capital requirements. This, in turn, makes it vulnerable to closure, nationalisation or forced sale. My stamp is my bond? Some large banks' shares are the price of postage stamps and their stock market trade-price is close to one year's net profit, even with G20 governments guaranteeing the banks' long term solvency! The news media informs and reflects widely held opinions of bank bonds (backed by assets comprising our loans and repayment schedules) that they're worth even less than postage stamps, certainly less than gold or diamonds that also pay zero income. It is possible to joke that postage stamps are rising in value: buy now and they are good to 'hold' for an annual 8% return? Are bank shares good to 'hold'? Medium to long term they must be.
In the short term now too maybe, if further dilutions by rights issues are avoided, and certainly if cash-flows can be decoupled from mark-to-market asset write-downs. This is the idea of assets valuations based on 'hold to maturity', and shifting assets from trading book to banking book, or the idea again (now called 'bad bank') of getting assets with below book value prices off the balance sheet, and so on, such as swapping toxic assets into bad banks or at central bank liquidity windows via SIVs or any form of medium to longer term warehousing, i.e. de-coupling cash-flow P/L so that banks share price valuations can move closer to banks book value (even if the latter is written-down, short or medium-term discounted by recession, cyclically) and if solvency is considered on a cash-flow basis, then bank shares must have tremendous up-side. But, the political authorities are reluctant to permit massive shareholder 'regains' (unless government or perhaps pension fund shareholders only?) If fiscal measures by US, UK and other governments deliver firm signs of recovery by 2010 (maybe with advance indicators in 2nd half of 2009) then the 'upside' potential of bank share prices becomes a powerful certainty!