Citi shares will soar if mark-tomarket accounting is modified

It appears that the regulators are finally examining issues with the current mark-to-market (MTM) policy governing regulated financial institutions (mainly banks), and close to provide new guidance for MTM accounting.

In concept, MTM accounting is a good thing, because it requires companies to report their assets at the true market value. However, in practice, such requirement has serious flaws, and is threatening (or has already threatened the viability of the entire US banking system). Many of the assets carried on the banks' balance sheet do not trade on a liquid market. To account for their market value is very difficult, and in many cases, seriously flawed standards have been applied to mark the value of the these assets. For example, it is seriously flawed to use thinly traded CDS contracts or CDOs to mark the implied value of these assets. CDS and CDO are not traded on a public exchange, and are subject to price manipulations.

What happened in this financial crisis was that banks were forced to mark down the value of their perfectly fine assets, due to the use of flawed market value indexes such as CDS and CDO. Hedge fund managers who have shorted bank stocks manipulated the prices of CDS and CDO, forcing banks to mark down their assets value, triggering capital shortfall and credit downgrades. In many cases, the assets that banks are forced to mark down are performing assets, generating steady incomes. After the mark down, banks have either to sell these assets at depressed valuation, or have to raise capital at prohibitively expensive rates.

What we need is a MTM accounting system that does not rely on flawed valuation methodology, but rather truly reflects the economic value of the assets.

I am hopeful that we soon will have a new set of MTM accounting guide lines that will reflect the true economic fundamentals of the financial institutions. If that happens, many bank stocks will soar. Citi shares can increase more than ten-fold easily.

With the current incredibly wide credit spreads, US banks must be making huge amount of profit. Yesterday's news about Citi is not an isolated event. I believe other banks are also generating handsome profits. In terms of really depressed valuation, I like Capital One (COF), which is trading at only 0.2 times of its book value! Obviously Citi is even cheaper. But Citi faces large dilution from government stakes in the company. So I prefer COF. WFC and JPM are also good investments at current prices.

Disclaimer: You should consult your financial advisers before making any investment decision. The above opinion is not a recommendation for anyone to buy or sell any stock or other financial assets. Invest at your own risk!