When is a Financial Company Insolvent?

Every now and then, I see a stupid post saying that a financial company is solvent if it is still making timely payments on its liabilities.  That is the Ponzi definition of solvency.  So long as there is an unclaimed dollar in the till, the financial institution is solvent.

To this I say “hooey.”  Financial institutions don’t have all that much to them.  They are just a bundle of promises.  “Parties I have lent to will pay me more than parties I have borrowed from.”  They are a bundle of longer-dated accruals.  The value of assets and liabilities can’t be firmly fixed in the same way that those of an industrial company can.  In that same sense, the current value of assets versus liabilities in a financial firm correlates highly with the trading value of its equity.

So when a financial company has a negative net worth on a fair market value basis, the odds of the common stock being wiped out is high.  Could the market come back?  Yes, but the odds are less than even.

This is my way of saying that regulators should take control of operating financial companies when the fair value of their net worth goes negative.  Like a good technical trader, honor the stop-loss.