Crisis created lasting doubt about asset valuations
One of the lasting impacts of the financial crisis of 2008-09 will be the greater level of doubt the public has about financial reports coming from large, publicly-held financial institutions. I am not saying that any financial institutions deliberately misstated earnings during this period, but I am saying that insiders did not always fully understand the value of some of the assets they held, which led to rosier financial reports than was likely warrented.
The banking industry reported record profits in 2006 and 2007 but many banks held portfolios of mortgage backed securities and collateralized debt obligations that certainly were not worth the valuations they received at the time. Nobody dug into these portfolios at the time to see what they were really worth; people who did look into them didn’t have enough historical data to assess accurately how a AAA-rated security with a fraction of junk in it might perform under various economic conditions. We know now, for example, that the probability of default on a cash-out-refi mortgage is greater than it is on a mortgage used to purchase a home. I am not aware that anyone was making these distinctions three years ago, which means many portfolios at most of the biggest banks were judged to be more financial sound than they actually were.
I know that whenever I see an earnings report from one of the largest banks — or any publicly-held firm for that matter — I wonder about the accuracy of the valuations assigned to assets. The sting of the financial crisis is still fresh in the minds of many people who pay attention to this stuff.
