I read a very interesting article recently that I think helps to explain our current economic situation and offers some hope for the future. It talked about how our economic situation was not caused by the Real estate downturn directly but by the mark to market legislation that was enacted after the Enron scandal.  It seems that this legislation requires companies to value their assets based on the most recent sales rather than actual value or risk imprisonment of the company executives.  Let's say that bank A had 30 million in loans against a capital reserve of 2 million or a 15 to 1 ratio.  Now let's say that they need to re-value this 30 million down due to the Real Estate devaluation.  This puts the bank into a outstanding loan valuation of, let's say, 28 million and the ratio to capital assets goes above the acceptable level.  This bank is forced to either raise it's capital(which it can 't because it's ratio is bad--and it's stock price drops) or sell off some of the loans which must be sold at pennies on the dollar now.  The bank that buys these loans at pennies on the dollar now has to re-value it's own loan porfolio based on the low value it just paid to bank A.  In addition  all the other banks must now devalue their loans to reflect this purchase too.   This is when we see bank failures, plumetting stock prices etc...

The good news is that when the fed steps in to buy these loans for pennies on the dollar it stops the effect on all the other bank valuations and the downward spiral stops.  It doesn't have to follow mark to market and the other bans are required to devalue based on this transaction either.  According to this economist the effect of this buy-out by the Fed can start to have a positive effect by the end of the first quarter of 2009.

In addition, Congress has given the SEC permission to modify the mark to market situation and an answer is expected by 1/2/09.  It's possible that it will change valuation from recent comparable sales to a cash flow method based on the value of cash coming from these properties.  If this occurs we might start to see the stock market recover as additional money comes off the sidelines and real estate values might begin to stabilize too.

I hope that I have given the gist of this article and that it gives us all some positve results in 2009.

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