"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.

>

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.

>

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

Category: Credit, Finance, Investing, Legal

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

76 Responses to “Fair-Value Accounting & FASB 157”

  1. Scott Frew says:

    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.

  2. Wendell says:

    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).

  3. HCF says:

    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

  4. gene says:

    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

  5. CNBC Sucks says:

    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.

  6. BarryB says:

    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?

  7. Bailout 2.0 says:

    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

  8. m3 says:

    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.

  9. Pat G. says:

    “to report losses they never expect to incur.”

    Well of course not, we got their back. Thanks Washington.

  10. matt says:

    “…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.

  11. Winston Munn says:

    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.

  12. debreuil says:

    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

  13. Greg0658 says:

    “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.

  14. Darkness says:

    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.

  15. Stormrunner says:

    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.

  16. Fred S. says:

    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.

  17. Fred S. says:

    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.

  18. Donkei says:

    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.

  19. Myr says:

    Thanks for the dose of sanity Barry. I may not agree with you all the time, but you have a great blog.

  20. D.L. says:

    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.

  21. Lover of Ham says:

    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..

  22. cloudy says:

    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.

  23. Lover of Ham says:

    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..

  24. mike e. says:

    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.

  25. Winston Munn says:

    It would seem the endgame of this appeasement attempt would be to change The Great Moderation into The Great Mollification.

  26. Robert says:

    Somewhat OT. Hey Barry – how about suggesting that, as an alternative to buying derivatives, the government buys commercial paper that ensures the money gets to Main Street.

  27. Wisdom Seeker says:

    If the corps want to mark-to-fantasy, they should be required to provide full disclosure so that the reality-based community can tell them what their balance sheet is really worth.

    For every asset etc. in which the corporation has a financial interest (all returned to on-balance-sheet status):

    What the asset is, what it contains, references to the full legal documents of the asset.

    What the notional value is. What was paid for the asset. What model is being used to value the asset (in full detail, including all pertinent assumptions including the statistical distributions). What the model says the asset is worth.

    Market data: What the last comparable asset sold for, and when. What the most recent bid and offer were for the comparable asset. Any differences in value between the comp and the actual asset on the books.

    You can have your models, but if you want to encode your balance sheet so that no one else understands it, the investing community will value you as a Cipher.

    Cipher = Zero.

  28. cloudy says:

    obviously, in the above post, I meant, if we go back to mark to whatever feels good…..

  29. Bruce in Tennessee says:

    The national debt goes above 10 trillion Tomorrow! Paulson’s request last week to raise the debt ceiling to 11.3 trillion will have to have a supplemental request very soon at these rates of debt accumulation. These boys are serious about bankrupting the government.

    Origin at Calculated Risk…I posted about the rapid rate of debt accumulation a couple of days ago, but didn’t realize we’d get to 10 trillion tomorrow….

    only a couple of weeks ago our debt/gdp ratio was 69.3%…tomorrow it is 71.4…

    When you have the world’s largest credit card the world is your oyster…

  30. alan davis says:

    In every previous downturn all are financial institutions would have been insolvent if we had been using mart to market rules. Read Steve Forbes comments in this week’s Forbes. Wayne Angel said the same on Kudlow some months ago. Two previous FDIC chairman have said on TV that the mark to market rules need to be suspended.

    Mark to market rules are not from God but the FASB. These rules are clearly flawed when applied to illiquid markets. Companies are forced to devalue assets that are not in default and/or have substantially higher cash flow valuations. And to force a capital raise as result is insane.

  31. Chris Hamilton says:

    Hi there,

    I tried contacting you a while ago but never received a response, can you please email me so we can discuss my proposal?

    Thanks

  32. Stormrunner says:

    Am I missing something here!!

    In what way does this engineered event not completely resemble the margin calls of ’29
    lending people money they could never repay, allowing banks to expand levelage many standard deviations above norm, then suddenly getting religion. This is a travesty. First by inflation then by deflation, do your homework. I hate this idea but 100,000,000 tax payers stuck for 7000 dollars each, most of us lost that in our 401k plans in one day. This wealth transfer must be stopped even if it costs money to do it.

  33. Winston Munn says:

    Maybe there would be more bailout support if Bush asked the EPA to put the remaining 16 Primary Dealers on the Endangered Species List.

  34. KJ Foehr says:

    Changing the accounting rules is like giving everyone magic eyeglasses that make it appear the Emperor has beautiful clothes. The problem is we already know the Emperor is naked!

    Or, as they said in the old days, changing the accounting rules isn’t going to make a silk purse out of a sow’s ear. — At least not in the credit markets, but it just might on Wall Street!

    “Kool-Aid! We need more Kool-Aid, fast! And put more acid in it, a lot more!”

  35. Fair-Value Revolution
    Historical cost accounting is fading as Corporate America marches into a new era.
    David M. Katz – CFO Magazine
    September 1, 2008

    What is a company really worth? That is the central question that accounting attempts to answer, and it is no easy exercise. Every answer invites debate, and that debate has now intensified, thanks to “fair value” accounting.

    Under fair value, a company values its assets and liabilities based on what they would fetch today, rather than what they originally cost. The concept is not new — accounting has long operated under a “mixed attribute” model, which records many items at historical cost while requiring that companies mark to market certain asset classes (such as securities, derivatives, and intangible assets obtained in a merger). But a host of factors have suddenly propelled the calculation of fair value from a secondary concern to a dominant theme of corporate accounting, and many companies are just beginning to understand the ramifications. If fair value takes full hold, as some have suggested it should, company results may look far different than they do today….
    http://www.cfo.com/article.cfm/11957243

    add’l info, CFO Magazine does a good job

  36. Maple Syrup says:

    MTM is only part of the problem but certainly an element, requiring institutions to mark all thier assets to the market periodically and making them adjust their capital adequacy on the basis of that mark was clearly not a well thought out policy. In a fire sale market, such as this one, it is akin to trying to get a mark on a set of winter boots in the blistering heat of summer.

    But to paraphrase Churchill’s comment on Democracy it is the worst system except when you compare it all the others.

    Accountants have been struggling for years to come up with a more sophisticated valuation mechanism, I await their next great idea with bated breath.

  37. Steve Barry says:

    Let’s see if I understand this…all accounting really is is putting numbers on a piece of paper in column A or in some other column. We are always told how the market over the long term has wisdom built in. So am I to believe that by just moving a number on a piece of paper to a different column, all else being equal, you can magically change the intrinsic value of the company that the market is willing to pay? That is the most laughable thing I have ever heard…maybe I’ll move my mortgage into an asset column on my balance sheet and see if this magic happens for my equity.

  38. MP says:

    Alan makes some good points above … it’s not like MtM has a long history and if recasted in the past, we may have been looking at some different pictures. It would be interesting to do a compare of a previous crisis and see what it would have been like w/ MtM accounting. It seems to me, it is part of the equation, and amplifies the violent turns of the market – which at the tails, is often illiguid or frozen.

  39. stuart says:

    What’s that famous line from the movie, A Few Good Men.

    “You can’t handle the truth!”

    how fitting.

  40. Steve Barry says:

    I used to own a Rochester NY Municipal Bond Fund…I notice it is down almost 6% in the last week…this is a major move for a muni fund and is just one more sign of incredible stress in the system.

  41. doc1 says:

    “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. ”

    BR,

    Dreck is right! As I said this A.M. (I think it was 4 a.m. Utah time) that the problem is that these MBSs and CDOs and SIVs have mortgages in them multiple times — meaning word is starting to come out from smart European bankers and other investors (some here in the USA) that the same mortgages appear to have been repackaged over and over again into various mortgage backed securities, seemingly as often as 40 or 50 times! Blatant fraud but when originated untrackable and “problem free” but now that the piper must be paid this little slight of hand is being uncovered. How many of these MBS are this way? And how do you price this fraud in? The banks and markets have already done that and decided these things are worth zero. Does anyone else (i.e. our governing officials?) see the problem?

    Washington D.C. THAT MEANS THESE ARE WORTH $0! Got it?

    So’s how Paulson going to hide these? Maybe that’s the plan — by buying them with taxpayer dollars and burying them forever in the belly of this beast being created by this bailout bill.

    Ugh. I cry for what we’re all about to do to our country…

  42. ya know, this is a beautiful topic/thread for it is dealing with a subject, Accounting, that Is Supposed to Balance, utilizing broadly agreed upon Rules that are Readily Knowable.

    Through this facet we can See, unaided, even if it is occluded through the others, the flaw in the Stone–being passed as IF.
    http://www.thediamondbuyingguide.com/diamondclarity.html
    http://www.thefreedictionary.com/occluded

  43. DCheney says:

    Folks, as has been noted by others, in every other downtown, every financial institution, including every insurance company, was insolvent for 2-3 years under mark to market.

    But we all had an agreement – we didn’t talk about it, and the problem, for most institutions, was earned away.

    I think the biggest problem Ben and Hanky Panky face is the internet, combined with the rigidity of the legal bankruptcy system.

    The fact that it appears that we can’t just walk past the graveyard whistling for 2-3 years thanks to the intartubes makes this one fundamentally harder than 89-92, 82 etc.

    As an aside, in a conversation about this, a person who should know admitted, for example, that his employer, a bank who shall remain nameless (JPMorgan) was absolutely stone cold broke as a result of the Mexican ef-up in 82 (82 if memory serves).

    Mark to what market exactly. Yesterday down 1.2 til? Today up 700 b? Yesterday I’m bad, today I’m god? And you complain about short-sighted management?

    Oh, and for the turbo-mark-to-markers – doesn’t your attitude create the problem on the upside. when the ballon is blowing up, you whine that bankers are earning enough of a return on their suddenly inflated capital, so they reach for alpha and get beta.

    pro cyclical, baby. It makes the ups so much more fun, and the downs so much more, er, fun.

  44. John Bougearel says:

    Well said,

    Guess we will have to get rid of the doctor if we are sick! LOL

    john bougearel

  45. So’s how Paulson going to hide these? Maybe that’s the plan — by buying them with taxpayer dollars and burying them forever in the belly of this beast being created by this bailout bill.

    Posted by: doc1 | Sep 30, 2008 11:12:07 PM

    doc,

    no ‘Maybes’ about it, that’s the plan: USTreas/Uncle Sucker’s balance sheet as Yucca Mountain.

  46. John Bougearel says:

    Representative Todd Tiahrt, a Kansas Republican, said the House probably would have approved a $700 billion bailout of financial companies yesterday had the legislation included a suspension of fair-value accounting. The House rejected the measure 228-205.
    It would have passed “easily” if the rules had been suspended

  47. John Bougearel says:

    If Tiahrt believes the vote would have passed easily if they could be allowed to kill the doctor pronouncing the patient deadk, this would be tantamount to permiting ccongress to vote see no evil believe no evil.
    Eliminating the rule would cleanse the guilty hands of congressman on capitol hill of their offense and offensiveness to the ammerican public.  

  48. John Bougearel says:

    thank god for bernanke admitting that removing the rule would erode confidence that firms are owning up to losses.

  49. Free markets says:

    These are the new and improved rescues, They will, for sure be better than that Paulson Asshatery. Cause now “Those Who Won” will get their way, and it couldn’t possibly that we will have an even more disastrous solution….

    New “Free market” solution is a sweet Less “free and transparent” market solution.

    One may even suggest that the Result of some Sweet “laissez-fair” economic Genius will be socialisum.

    Charming how the market has gone down the rabbit hole.

  50. Jojo says:

    @CNBC Sucks said “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 have been thinking the same thing. The DEMS have been counting on winning the election AND (I think) also getting a veto proof majority in Congress.

    That may not happen now if they push this vote through Congress despite the wishes of the majority of their constituents.

    Another Democratic election failure will come out of the hide of Pelosi and Reid. I’d wager that Pelosi might even face a recall.

  51. AGG says:

    So Hank is going to attach a bunch of ticks to us to stop the bleeding (of the ticks). He’s right. This is all about the taxpayers. It’s always been all about the taxpayers ever since the first troll started forcing people to pay a toll to cross a bridge. Now this fine art has been perfected. If you move to the side of the bridge that you work at, then you are given the patriotic duty of paying “your” share of the toll for those who do. I have a message for Hank Paulson and his ilk. Airline flight attendants, waiters and servants of all types have a way of dealing with people like you. You don’t know what it is, do you? My sister flew for Eastern Airlines many years ago. Some of the stews would do wonderous things to the meals they served some recalcitrant Captains. Lucelle Ball from “I love Lucy” was a particular pain in the ass in first class and the stews would watch her scarf down here “food” with glee. No, it certainly was not poisonous or impaired her health. Enjoy your meals at your getaways and fancy restaurants, fat cats.

  52. Rubens Morse says:

    Barry, thank God you are a blogger and not a bank regulator. If today’s mark-to-market rules were in effect at the time of the Latin American Debt Crisis, a number of banks would have been insolvent and would have gone out of business: Citibank, Chase, Deutsche, Lloyds, etc. Big part of the current crisis com from the vicious cycle of deleveraging: distressed banks sell assets at depressed prices, then other banks have to mark down their assets to those depressed prices, sell more assets to raise capital, and so on.

  53. attobuoy says:

    The problem is that the junk really is just about worthless, but the banks won’t admit it. See the column by Daniel Gros at http://www.voxeu.org/index.php?q=node/1714:

    ————————————

    ‘No recourse’ and ‘put options’: Estimating the ‘fair value’ of US mortgage assets
    Daniel Gros
    27 September 2008

    “How much are the toxic assets worth? A bit of logic and a straightforward application of the Black-Scholes formula suggests that if current expectations of house price declines are right, securities built on subprime mortgages might be close to worthless. The key is that US mortgages are ‘no recourse’ loans, i.e. debtors can walk away from the mortgage without being held personally liable, a feature that gives homeowners a virtual put option.”

  54. Alex says:

    If it is deemed that certain securities are truly undervalued only because of the current credit situation and a firm has every intention and ability to hold the securities until either maturity or the situation improves and would like to get credit for those securities (i.e. capital purposes), then I would want to see the securities specially exempted from mark-to-value posted publicly so the market can scrutinize the firm’s value given to said securities.

  55. Jeff says:

    So with this and the push for the Fed to lower interest rates when they should be raised, it seems pretty clear that Washington and Wall Street have chosen “the Japan model”

  56. AGG says:

    I’ve got a Classic Automobile worth $500,000 under my mark to maturity rule. Yeah, I know it’s a 1997 escort and it barely runs but it “matures” in 2030 as a classic. I guess I can go to Hanky for loan collateral at 12 to one. Make me a check out for $6,000,000. I’ll pay you back over 30 years at 2%. Thanks all you great taxpayers.

  57. wunsacon says:

    And then what, Rubens? There would’ve been more discpline afterwards! (Serial bubble-blowing is no way to live.)

  58. HCF says:

    Just read Wednesday’s WSJ editorial section and it has me absolutely seething… Both the editorial board and Brian Wesbury have op-eds essentially blaming mark to market for the current market problems.

    Very few people (most of the audience here excluded) point to the actual causes of the current financial crisis:

    1) Too many unqualified borrowers
    2) Crappy, overpriced assets as a result of speculation by aforementioned unqualified borrowers
    3) Excessive leverage on the belief that the crappy, overpriced assets would always go up in price. Hey, selling the same assets back and forth to each other at ever higher prices is of great economic value!
    4) Inherent illiquidity of assets because it’s really a hot shit potato that no one wants to catch!

    Where does mark-to-market fall into this? In retrospect, many financial businesses accepted far too little yield for the excessive LIQUIDITY risk they were taking. To compensate, they leveraged to their noses, and laughed all the way to the bank for being ‘geniuses’. Now, with no market to speak of, they can’t cover their expenses and hence are insolvent. You live by the gun, you die by the gun. Prepare for a rainy day. [Insert your favorite folksy saying here].

    You might have a million dollars worth of baseball cards or beanie babies, but if you have to pay the rent, and your landlord isn’t 12, it might be prudent to keep some cash around, lest you have to experience mark to market!

    Ok, enough rambling…

    HCF

  59. baychev says:

    if anything, fair value accounting more often overstates, rather than understates prices for banks: it is based on last trade whose volume is presumably smaller than big players’ holdings. for individual investors with a couple of hundred securities it may understate prices.

  60. Blackhalo says:

    “If today’s mark-to-market rules were in effect at the time of the Latin American Debt Crisis, a number of banks would have been insolvent and would have gone out of business: Citibank, Chase, Deutsche, Lloyds, etc.”

    Where is the downside?

    If these were the bad actors of yesterday, what makes them useful today. What if they had failed, and the economics professors MBAs and banks of today could point to that event as something a financial institution should NOT do.

  61. Jerry says:

    We’re considering drastic measures already – taxpayers buying these close to worthless assets – so what does it matter if we screw with accounting rules for awhile? We can still force transparency without forcing companies to raise more capital – from us! Make them reveal what they own and make them hold this shit to maturity or sell when they see fit. If other banks refuse to deal with bad banks causing them to fail the FDIC can do what they just did with WAMU.

    The fees banks pay to the FDIC can be raised if necessary. Let the damn financial industry pay for it all.

  62. constantnormal says:

    This reminds me of the recent bans on short-selling. When the Congress has no problems with simple and easy answers, they grab the simple and easy wrong answers and try them anyway.

    If only there were some punishment for elected officials when they behave like this — like throwing them out of office — but that’s just crazy talk, it would mean breaking the cherished principle of election via incumbency!

    I suppose that if the taxpayers allow themselves to be screwed in $700B increments, they deserve what they get.

  63. Patrick Neid says:

    Everyone keeps complicating the issue usually talking their books.

    Folks such as myself who asked for a review and a possible suspension did so for technical reasons. Simply put, you cannot mark to a market that currently does not exist. What part of that are you having a problem with?

    Aside from a few lobby groups no one to my knowledge has asked for a permanent ban.

    And despite the selective editing used in this link the SEC and the FASB have granted said review and they have made some appropriate changes. Most of you would not understand those changes because you have not read FASB 157 nor do you know its legal implications during moments of crisis.

    This is the important message left out of the edited quotes above:

    “Anne Canfield, executive vice president of the Consumer Mortgage Coalition, counters that businesses have been forced to “mark down their assets to unrealistic fire-sale prices,” because trading has dried up. Canfield, whose group represents mortgage lenders, urged the SEC to suspend fair-value rules “immediately” in a Sept. 29 letter to the agency.

    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.

    The American Bankers Association, a trade group representing lenders that has lobbied the SEC over fair-value accounting, praised the agency’s clarifications, saying they will “help auditors more accurately price assets,” according to a statement released today.”

    This for the most part is what we were asking for.

  64. Olaf says:

    Here it is: SEC Office of the Chief Accountant and FASB Staff Clarifications on Fair Value Accounting

    Something like “If it’s good for you, you may use mark-to-market. If it’s bad for you, don’t use it.”

  65. Blue Steel says:

    I admit to being a little confused; a financial neophyte who is learning along the way.
    Yesterday I watched the movice “Enron: the Smartest Guys in the Room”, and they talked about one of the factors in Enron’s house of cards was their employment of the mark to market rule – basically booking profits before they existed. Now many of you (and BR) are talking about how we need the ‘transparency’ of mark to market, rather than this suspension of the rules to make banks feel better about their balance sheets. What’s the deal?
    To add a further question, this bailout is supposedly about purchasing some of the toxic assets from banks, etc. – but at what price? If we change the accounting rules, and the big shitpile of dreck is now worth 77 cents on the dollar instead of 23 cents – won’t the taxpayer be overpaying that much more?

  66. auditor says:

    So why can’t the companies and the analysts show the “real numbers” via pro forma information as they do all the time anyway? Then the reader would have the option to believe what he wants?

  67. auditor says:

    So why can’t the companies and the analysts show the “real numbers” via pro forma information as they do all the time anyway? Then the reader would have the option to believe what he wants?

  68. Greg0658 says:

    consider:
    “banks must pay county property taxes on all held property on a quarterly basis”
    versus:
    current system of the next buyer pays all property taxes
    will:
    put some jump in their step to price assets to sell

  69. Martin says:

    I agree with Wisdom Seeker (Sept. 30, 9.41). If banks, etcetera, are allowed to deviate from marking to market, they should provide complete transparancy as to how they arived at the valuation using their own model. So, they should show what those assets are exactly, how the model works, what variables they use for valuation (yield curve, spreads, assumptions as to default and recovery, and what have you), and what the results would be if those variables are changed.

    In short, they should build some tool and put it on their website so that every investor and depositor can make his own version of a bank’s balance sheet, and base his investment decisions on the outcome of the scenario that he/she thinks it most correct.

    I admit that it would take some programming, but it would make a bank’s finances much more transparent than the present situation, where the time lapse between a CEO saying everything is great, just fine, no liquidity problems at all whatsoever, and a bank going belly-up can be as little as two weeks.

    It would also render rating agencies superfluous.

    But let’s not kid ourselves: the most likely outcome of this issue is that rule 157 is suspended partially (nobody knows exactly which part) for an unclear periode (nobody recalls how long exactly) with respect to some types of assets (which no bank will be very clear about). The result: a balance sheet that might or not might bear any relation to the truth, whatever that truth might be.

    On the other hand: it is quite likely that the American taxpayer (represented by whatever body is going to spend that $ 700 billion) is going to overpay significantly once TARP is put into place, so by then US banks can probably use those prices as “observable inputs”. And report lovely balance sheets, which, incidentally, aren’t completely off the mark since those $ 700 billion are going to be just the tip of an iceberg.

    Conclusion: by, say, Q2 2009 we can work with the TARP phony-market prices, and all will be well. This FAS 157 problem only relates to the 2008 Q3 and 2008 Q4 numbers. What’s two quarters of crazy numbers if we can avert a complete meltdown -as messrs. Paulson and Bernanke are assuring us will happen?

  70. Folks such as myself who asked for a review and a possible suspension did so for technical reasons. Simply put, you cannot mark to a market that currently does not exist. What part of that are you having a problem with?

    There is a market, but in the absence of transparent valuation, the true value is zero.

    MARK IT ZERO NEXT FRAME.

    YOU ARE ENTERING… A WORLD OF PAIN.

  71. Diogenes says:

    BR.. Gotta disagree with you.. FASB 157 was passed back in 2007, CORRESPONDING to when everyone started questioning the valuation of these Mortgage Backed Securities.

    I don’t think that’s mere coincidence.

    In fact, I opine that it is one of the primary causes of this financial mess, along with inflated credit ratings from Moody’s/S&P suddenly deflated as they incorporate FASB projections.

    The result was to, in effect, prick the real-estate bubble because it altered the entire basis upon which mortgage backed debt/assets had been valued up to that time.

    We haven’t seen anything this deflationary to asset prices since Churchill returned England to the gold standard in 1925 (just in time to fuel the Great Depression).

    Thus, it stands to reason that one of the “band-aids” required is to revise FASB accounting as it applies to Mortgage Backed Securities.

    Think about it.. Why must banks write down the valuation of a performing asset merely because there is a illiquid market, or some hedge fund seeking to cover their short sale offers .20-.30 on the dollar??

    Do Americans, as home owners obtain the ability to write down the value of their home (and thus reap tremendous savings on their property taxes) just because their neighbor had to execute a short sale that clipped 25% off their value of their home?

    There’s a REAL (and ridiculous) tendency to think we can apply accounting methodoligies for designed for liquid markets, to illiquid assets being held for long term maturity. You just can’t call up your realtor/broker, obtain a quick price quote on your home, and then push the sell button.

    And when you take a look at truly liquid markets like oil, you see M2M “fixes” twice a day.

    Bottom line.. I don’t like Mortgage backed securities. But so long as they exist, they should be valued very closely to the mortgage debt contained within them.

  72. DmitriyD says:

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  73. I don’t like Mortgage backed securities. But so long as they exist, they should be valued very closely to the mortgage debt contained within them.

    But how much is that debt actually worth, in this world of overcapacity (devaluing the underlying asset), overleverage (debt-to-income far beyond rational) and non-recourse loans aka Jingle Mail?

    It’s worth what Mr. Market says… The only answer IMO is to depackage these MBS and analyze the mortgages one-by-one on their own merits with the actual housing market taken into account.. And not by the conflicted-interest ratings agencies that got us into this damned mess..

    Or, when a bad apple has spoilt the barrel, you toss the barrel and take your losses like a man.

    BTW, I like the foreclosing-bank-on-the-hook-for-property-tax idea very much I have to say.. It’ll either slow foreclosures or force a market.

  74. Larry Rock says:

    Anybody remember the Enron disaster? Part of that meltdown had to do with manipulation of mark to market valuation. Government regulators were complicit in allowing the company to show more profit than was ever going to materialize.

  75. tf says:

    you realize that LIBOR is not a market rate right? LIBOR is misleading on a variety of levels when you consider how it is actually calculated. the WSJ ran a good piece on this several months ago.

  76. David Merkel says:

    Everyone take a deep breath. All of these issues have been around since 1999, when SFAS 133 went live. SFAS 157 only clarified things.

    In the end, the cash flows will appear, regardless of the accounting.

    Thanks for the mention, Barry.