Fair-Value Accounting & FASB 157
"Blaming fair-value accounting for the credit crisis is a lot like going to a doctor for a diagnosis and then blaming him for telling you that you are sick.''
-Dane Mott , JPMorgan Chase & Co.
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The debate on fair value accounting, FASB157, and transparency continues apace. If you want to understand why this is so important, just see LIBOR tagging all time highs today.
Banks don't want to lend to each other because they are not sure how much explosive dreck is in the other guy's balance sheet. Hiding the junk isn't going to help this at all . . .
Bloomberg:
"The U.S. Securities and Exchange Commission probably will resist calls to suspend the fair-value accounting rules that some members of Congress blame for exacerbating the global financial crisis, people familiar with the matter said.
The SEC and Financial Accounting Standards Board today issued "clarifications'' on how banks should interpret existing rules requiring them to review assets each quarter and report losses if values decline. A moratorium isn't being considered, said the people, who declined to be identified because the plan hasn't been completed.
Congressmen, banking lobbyists and companies including American International Group Inc. have urged the SEC to suspend fair-value accounting, saying it forces firms to report losses they never expect to incur. Federal Reserve Chairman Ben S. Bernanke and other proponents say removing the rule would erode confidence that firms are owning up to losses."
I don't see how transparency and accurately reporting investment holdings works against investors. I can see how allowing banks to hide this junk might prevent them from lending to each other.
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Source:
SEC, FASB Resist Calls to Suspend Fair-Value Rules
Jesse Westbrook
Bloomberg, Sept. 30 2008
http://www.bloomberg.com/apps/news?pid=20601087&sid=agj5r6nhOtpM&
Summary of Statement No. 157
Fair Value Measurements
http://www.fasb.org/st/summary/stsum157.shtml
Tuesday, September 30, 2008 | 07:41 PM | Permalink
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Comments
Were I a witty cartoonist, which you will see momentarily that I most emphatically am not, I would be working Cox, Bernanke, and Paulson into monkey images with the Hear No Evil, See No Evil, Speak No Evil theme. Given the tendencies of this government, I'd then add Bush and Think No Evil, just to square the triangle.
Posted by: Scott Frew | Sep 30, 2008 7:51:39 PM
But it looks like Newt got his way; see:
http://www.washingtonpost.com/wp-dyn/content/article/2008/09/30/AR2008093002298.html?hpid=topnews
and, in the article you cite:
"The SEC and FASB, in today's statement, encouraged companies to rely more on their own judgments, such as expected cash flows, in determining the current value of assets that aren't trading. The regulators also said price quotes provided by brokers when markets are frozen may not be the most reliable way to determine how much securities are worth.
Norwalk, Connecticut-based FASB, which writes U.S. accounting rules, is preparing ``additional interpretive guidance on fair-value measurements'' to be released this week, the SEC said. FASB will discuss fair-value accounting at its board meeting tomorrow."
My guess is that we will be back to valuing this sludge at 79-84 cents on the (par) dollar, up from about 22 cents now (and we're short a bunch of regional banks who will now survive for months at least).
Posted by: Wendell | Sep 30, 2008 7:53:13 PM
Gotta love the hypocrisy... So many "free market" types (i.e. the posers) say "the price is what the market says it is" until they say "...except when a market doesn't exist. Then we should be able to mark to whatever the hell we'd like"
I seriously feel ill by the crumbling of our free market and constitutional principles.
HCF
Posted by: HCF | Sep 30, 2008 7:53:22 PM
One variation I heard is that Paulson’s buddies will form new companies and have G-Sax leverage loans and convert debt into equity that way as a way to keep up shareholder equity – then they will sell at the artificially high price back to others like them in a mini - bubble. They will steal the money the same way they stole it before, what a surprise
Posted by: gene | Sep 30, 2008 7:58:11 PM
The Dems are about to snatch defeat from the jaws of victory with a Senate vote tomorrow night. It is amazing how Paulson's mind games have worked - not only are the Dems risking their 55 in the Senate but an Obama victory in November. I switched political parties to the Democratic Party and I am seeing my side give up the capacity to effect change because of an utter lack of economic and financial knowledge and willingness to ignore the desires of the American people.
Posted by: CNBC Sucks | Sep 30, 2008 7:58:23 PM
The opponents of mark-to-market want to use mark-to-maturity (I believe Kudlow is in this camp). But what is the relevance of maturity when there is a good chance that the debtor will not even be around tomorrow?
They claim that the financial firms cannot recapitalize because of their artificially impaired balance sheet. Isn't the whole point that an investor could make a proper valuation from the known (i.e. market) vs the unknown?
Posted by: BarryB | Sep 30, 2008 8:05:43 PM
Fair Value is only appropriate in a non-recessionary period.
Or if you prefer..."Screw you guys...I'm taking my ball and going home."
Visual Aid:
http://imagecache2.allposters.com/images/pic/HPM/SM1109~Screw-You-Guys-Posters.jpg
Posted by: Bailout 2.0 | Sep 30, 2008 8:07:01 PM
i completely agree.
however, if i had to choose between suspending this, and have someone steal $700b from my back pocket, i prefer the solution that doesn't cost me any money.
Posted by: m3 | Sep 30, 2008 8:10:21 PM
"to report losses they never expect to incur."
Well of course not, we got their back. Thanks Washington.
Posted by: Pat G. | Sep 30, 2008 8:17:03 PM
"...urged the SEC to suspend fair-value accounting, saying it forces firms to report losses they never expect to incur."
Are you kidding me?! That's the nature of a loss; otherwise, no one would ever lose money (because they would never invest in something they expect to lose on). To say that they no longer need to recognize losses reduces market transparency and undermines confidence in markets.
Posted by: matt | Sep 30, 2008 8:19:36 PM
Fair-Value Accounting as explained by Hank Paulson with translation by Lewis Carroll:
'Stigand, the patriotic archbishop of Canterbury, found it advisable — "'
'Found what?' said the Duck.
'Found it,' the Mouse replied rather crossly: 'of course you know what "it" means.'
'I know what "it" means well enough, when I find a thing,' said the Duck: 'it's generally a frog or a worm. The question is, what did the archbishop find?'
At last the Dodo said, 'everybody has won, and all must have prizes.'
Alice thought the whole thing very absurd, but they all looked so grave that she did not dare to laugh; and, as she could not think of anything to say, she simply bowed, and took the thimble, looking as solemn as she could.
Posted by: Winston Munn | Sep 30, 2008 8:20:03 PM
With all the crying yesterday that due to us not forking over 700 billion, "$1.2 trillion vanished from market", we need to extend that logic today. The market gained around 700 billion today, so there is your bailout, enjoy.
PS BR's picture came up on google news today (business section) with the RGE article. Nice - when google is finding you you know people are listening : ).
http://www.rgemonitor.com/globalmacro-monitor/253793/fed__treasury_needs_to_stop_targeting_asset_prices
Posted by: debreuil | Sep 30, 2008 8:27:40 PM
"utter lack of economic and financial knowledge" abounds in this system to keep major dudes with a game edge. Our Legislators and their staff with "utter lack of economic and financial knowledge" need to write simplification into law.
Posted by: Greg0658 | Sep 30, 2008 8:28:15 PM
The lie must continue! If it does not continue, er, nothing will work right.
So, say I'm a bank and you're a bank, and we both have bad paper we have been forced to mark down and so tomorrow we can pretend it is magically worth more and so the numbers look better. All of a sudden you become a better candidate for a three day loan? Because I'm apparently utterly delusional and believe numbers, even made up ones? Well, that logic would adequately explain this whole mess, I suppose.
Ug, when to the frog marches start? I want a frog march for every billion in any bailout. I'd prefer no bailout, but barring that I want heads rolling.
Posted by: Darkness | Sep 30, 2008 8:35:35 PM
This is not a judgement of the grail of "mark to market", just the timing of its reimplementation.
For the purposes of argument, housing fluctuates around a historical norm plus inflation roughly equivilent to 2.5 times the household median income of the locality. So the value of these securities can be estimated within "reason". To allow the system to lever to this degree, by allowing "Mark to Fantasy" causing asset appreciation many standard deviations above historical norms then, instantly flip to GAAP, is to play straight into the hands of the "pigmen" this shortsighted stubbornness will cost 700 Billion ++++, with assets flying straight into the coffers of "friends of Hank". A measured approach to equilibrium "scaling in" is the correct coarse of action with the ultimate goal of indullable "mark to market". What's being suggested here activates the weapon of the "Great Margin Call" that has been used in every wealth transfer since the implementation of Fiat.
Posted by: Stormrunner | Sep 30, 2008 8:37:58 PM
This has nothing to do with investors. This all about keeping the banks afloat. If they do suspend it then they should be forced to add some additional amounts to their loss reserves. Better yet make it optional. They can use either method but must disclose which they are using. Remember these are 'exigent' circumstances.
Posted by: Fred S. | Sep 30, 2008 9:01:59 PM
This has nothing to do with investors. This all about keeping the banks afloat. If they do suspend it then they should be forced to add some additional amounts to their loss reserves. Better yet make it optional. They can use either method but must disclose which they are using. Remember these are 'exigent' circumstances.
Posted by: Fred S. | Sep 30, 2008 9:02:59 PM
To say that accounting rules are responsible for this massive de-leveraging is tantamount to saying process trumps substance, and that investors can't see through the process to get at the substance, just because of the way the SEC requires the substance to be reported. If the SEC required Exxon to write down the value of its oil wells such that it looks unprofitable on paper, would that change the reality of it having earned billions? No. Cash is cash, and the value placed on an asset for a balance sheet means much less than the cash the asset throws off. Smart people in the markets know and understand this, but the more the rules change, the harder it is to see through haze.
Anything the government does that unsettles the markets or changes the rules, especially in the ongoing turmoil, will have a deleterious impact on the ability of the markets to find a price. If the markets can't find a price, there will be no transaction. It's as simple as that.
Posted by: Donkei | Sep 30, 2008 9:06:11 PM
Thanks for the dose of sanity Barry. I may not agree with you all the time, but you have a great blog.
Posted by: Myr | Sep 30, 2008 9:21:05 PM
I agree completely with m3 @ 8:10:21 PM.
Normally, I would say the more transparency the better, but in the present situation, anything that undermines the arguments of the money-grabbing socialists in the House and Senate is fine with me. Furthermore, by fostering a debate over this issue, backers of this proposal are helping to draw attention to the fact that these assets are impossible to value; if the average voter can be persuaded that the treasury is likely to overpay for these assets, then he/she may be more reluctant to support it.
This is not about what should happen in an ideal world. This is about gaining political support for one position or another.
Posted by: D.L. | Sep 30, 2008 9:29:36 PM
The problem in the market is clearly short selling and mark-to-market accounting rules. Had those silly rules not been in place, companies like AIG, Bear, Lehman, Washington Mutual, Fannie and Freddie would still be around..
Bwwaaaa haa haa haa..
Posted by: Lover of Ham | Sep 30, 2008 9:32:31 PM
if we go back to mark to market, are the ratings agencies going to suddenly upgrade CDS, CDO, and MBS paper? (Don't people realize that the way they have sliced and diced these RMBS, that some paper can become worthless if just a fraction of loans default? )
Or will this favorably impact balance sheets so ratings agencies will give AAA to bank issued paper that they had on credit watch the day before? What disclosures, if any, will banks have to make of changes to paper, Tier I,II, III, etc., from mark to market to mark to infinity? (i.e., if assets increase x amount, how much of that is attributed to repricing per this change instead of actual market price?)Or will ratings agencies keep ratings on paper issues at say low ratings, but since the capital position of the institution has improved, the ratings agencies can now give more positive ratings to new paper the institution wants to issue
And when I go apply for a personal or business loan, can I value my house at the value to maturity, can I value a piece of idled equipment what it would be worth if demand exceeded supply?
the possibilities are limitless. but since thinking things through doesn't seem to be the hallmark of regulators these days, I won't be surprised at anything.
sorry my writing isn't clearer, but all this logic coming out of washington and wall street has my head spinning.
Posted by: cloudy | Sep 30, 2008 9:34:28 PM
The problem in the market is clearly short selling and mark-to-market accounting rules. Had those silly rules not been in place, companies like AIG, Bear, Lehman, Washington Mutual, Fannie and Freddie would still be around..
Bwwaaaa haa haa haa..
Posted by: Lover of Ham | Sep 30, 2008 9:36:49 PM
That Dane Mott is a very rich idiot. No one is blaming fair value accounting for the credit crisis. Fair value accounting was just one risk factor that led to the patient's heart attack. It didn't cause the heart attack...but it helped make it worse. If you need an explanation why it made matters worse then you are not an accountant.
America's economy is like an elderly, obese man, who smokes 2 packs a day, drinks, has high cholesterol, and is stressed out because he works 80 hours/week. Lots of risk factors here. The patient needs lots of medication. PROVIDING accounting GUIDANCE helps. The SEC is not ending fair value accounting...they just provided addtional guidance. Leave transperency to the experts. Don't start whinging about this guys...the market has only had fair value accounting for a short time.
Posted by: mike e. | Sep 30, 2008 9:37:16 PM
It would seem the endgame of this appeasement attempt would be to change The Great Moderation into The Great Mollification.
Posted by: Winston Munn | Sep 30, 2008 9:39:15 PM
