Friday, February 27, 2009

Asset Pricing 101

Peter Wallison has an opinion piece about valuing bank assets in the Wall Street Journal. A quick summary:

Both taxpayers and banks could come out well -- and so would our economy -- if the government were to buy the assets at their "net realizable value," which is based on an assessment of their current cash flows, discounted by their expected credit losses over time.
The article is a real world confirmation of the basic principle underlying all introductory finance courses: assets are worth the present value of their expected cash flows. This is what market value should be if the market is functioning properly. Clearly, the market for mortgage-backed securities isn't functioning at the moment.

Labels: ,


Blogger Fiona said...

Well, as a finance illiterate (I took your quiz, and I was 50-50 - eek), the valuing an asset at its current market value seems sensible and I wonder, why wouldn't governments do that???

1:50 pm  
Blogger Karen said...

Fiona, the main question at the moment is whether market value truly represents the net realizable value (PV of future cash flows) of assets when there is next to zero demand for the types of assets banks are holding right now. The article suggests replacing market value with net realizable value for this reason.

11:23 am  
Blogger Fiona said...

Thanks Karen! Now I get it.

12:52 pm  

Post a Comment

<< Home