Suspending Mark to Market Remains Unlikely
Dan Greenhaus is at the Equity Strategy Group at Miller Tabak + Co. where he covers markets and portfolio theory. He has contributed several chapters to Investing From the Top Down: A Macro Approach to Capital Markets (by Anthony Crescenzi).
This is his most recent commentary:
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Suspending Mark to Market Remains Unlikely
Decreasing transparency has never, and will never, be the answer
MARCH 18, 2009
I will reserve comment about the proposed changes/amendments/guidance regarding FAS 157 until such adjustments are implemented, but I wanted to make a few quick observations regarding FAS 157 and related topics:
To begin with, FAS 157 does not establish the concept of fair value accounting. Companies have been
reporting assets at fair value for years. What FAS 157 did was establish an outline for how companies
should value assets through the Level 1, 2, 3 system with Level 1 assets being the most accurately valued and Level 3 being the least accurate, the so called “mark to model” assets. Suspending that system would, in my mind, unquestionably increase market uncertainty by increasing management input with respect to the valuing of assets. How in the world anyone thinks reducing transparency, which is absolutely what would occur, is a good idea is beyond my understanding. I do not subscribe to the belief that the perceived lack of transparency now, the effect of distressed markets, excuses further reductions in transparency by removing the guidelines, outlines and disclosure requirements as laid out in FAS 157.
Secondly, I also do not subscribe to the belief that somehow these assets are not being priced to their “true” value. While there is certainly some temporary impairment due to market volatility and perhaps some underpricing relative to hold-to-maturity value as we believe it to be today, the fact remains that an asset trading at a significant discount to its true value would attract buyers in larger numbers than we’re seeing. The truth is that these assets are not seeing the interest they otherwise might be for a variety of reasons, not the least of which is that the “true” value of these assets are in contention right now. Could the value be higher than, say, 30 or 40 or 50 cents on the dollar? Sure. But I don’t know that and with high levels of macroeconomic uncertainty hanging over our heads, I believe that many market participants are staying away for fear of incurring losses on these positions.
Thirdly, the argument now being floated is that we need to suspend mark to market accounting to
accomplish two things; to cease the “unnecessary” capital raises by financial institutions, and thus the
dilution of current equity holders, and to cease the improper pricing of assets thanks to forced sales in
distressed markets. I would repeat an earlier assertion I made regarding Japan and their move to allow
banks to hold assets at amortized cost. The change in accounting standards made the Japanese banking
sector look healthier than it actually was. We are all aware that the Japanese took several steps which
lengthened their current malaise and surely the mark to market adjustment played a part.
Who knows where Japan would be today had their government forced their banks to quickly asses their
situation, write down assets, raise fresh capital to plug the holes in the balance sheet and move on. We
know that even today, nearly 20 years after their crisis began, the Japanese banking system remains in
less than healthy condition. We will never know how things would be different but we do have an
opportunity here in the United States to keep mark to market accounting in place and deal with this
situation in a far timelier manner than Japan.
And lastly, I would simply note that the FASB is set up to be an independent agency, free of influence
from outside individuals, specifically Congress. Quite simply, it makes my blood boil when I see
legislators in Washington, the overwhelming majority of which are not accountants and have never
been, commenting on what they think is best for markets from an accounting standpoint. It is
infuriating. To say that the FASB’s interested are not the same as elected officials in Washington is to
say the sky is blue and water is wet. It is obvious to the highest degree. Taking that one step further,
the adjusting/amendment of this rule as a result of political pressures compromises the FASB’s
independence going forward and one must question whether future decisions will be made purely at the
behest of those in Washington. On that note, I would hope to see absolutely nothing come of
Congressman Perlmutter’s bill which would increase the ability of financial regulators to determine
what accounting rules should and should not be followed by financial institutions.
Suspending mark to market accounting is a major topic du jure and any number of analysts and
participants are weighing in on both sides of the equation. But I repeat my belief that reducing market
transparency can only have negative effects on investor confidence and those advocating a complete
suspension of mark to market accounting are confusing to me, to put it lightly. I do concede that
adjustments can be made to the rule which will strengthen its effectiveness while increasing clarity
with respect to distressed markets and forced sales, the entirety of which can only have positive
benefits. But amending and clarifying the rule is a far cry from its suspension and those that advocate
its suspension are a far cry from making sense.
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March 19th, 2009 at 3:54 pm
Amen. I cringe everytime I hear some ‘pundit’ on TV using fasb157 as the scapegoat to all of their problems.
March 19th, 2009 at 5:43 pm
It seems to me that the issue of “mark to market” is intimately connected with two other issues: (a) capital requirements that the banks have to meet, and (b) bailouts.
I would go so far as to say that a discussion of “mark to market”, unaccompanied by a mention of the other two issues, is almost meaningless.
In other words, we could maintain the rules for “mark to market”, but at the same time, engage in some degree of forebearance with respect to capital requirements.
For me personally, the issue of bailouts completely overshadows that of “mark to market”. If liberalizing the “mark to market” rules, or alternatively, liberalizing the capital requirements (that banks have to meet) can in any way mitigate the insatiable desire of the politicians to bail out financial institutions, then I’m 100% in favor of it.
March 19th, 2009 at 5:56 pm
I’d pay (well, indirectly by clicking on ads perhaps) to see a debate between Dan Greenhaus and Chris Whalen on this issue.
March 19th, 2009 at 9:41 pm
the author’s whole premise is based on a misunderstanding of the facts – nobody is arguing for a suspension of mark-to-market (or if they are, they’re extreme voices that don’t really factor into the discussion) – its a modification to prevent its more harmful and unnecessary side effects
regarding your first point – fine, keep the transparency of the marks, but get rid of the noose that these companies are forced to hang themselves with by making them take the ‘loss’ through their capital – if you as an investor then choose to write-down their capital from these unrealized losses Ithat they may never take), then thats your prerogative – and you’ll be armed with all the information you need to do that – but otherwise, modifying the rule so they don’t have to take the loss through GAAP or regulatory capital will give these firms the time needed to weather the current illiquid markets and these assets will mature in full and on time
(note: I’m not talking about the toxic assets, I just mean those that are not currently, and not likely to become, permanently impaired)
regarding your second point – try this drill – go out and buy a 3-month piece of commercial paper – you can choose your issuer – now, turn around and try to sell that piece! – you’ll be lucky if you get a bid – whatever bid you get will be an eye-opening discount to what you just paid – now, imagine a *complex* RMBS with a 30 year final (or whatever term or ABS/MBS you want) – multiply the discount you found on the CP simply because this RMBS is a longer piece of paper and isn’t plain-vanilla corporate debt – now look at an on-the-run US Treasury vs. an on-the-run… why is there such a substantial discount?? – in your view, all these price differences from ‘intrinsic’ value should be arbed away – but the fact is they’re not – deleveraging is ongoing and brokers don’t want to take positions on their balances sheets in their traditional role as middleman – but the illiquidity caused by this process does not mean that ALL assets are fundamentally impaired
third – the Japanese situation had nothing to do with securities and mark-to-market – that was bad loans, partly related to the incestuous nature of the lending market there – completely different issue
DL has got it right
March 19th, 2009 at 9:48 pm
I had a long reply but it somehow disappeared
so all I’ll say now it – author is way off – DL has got it right
Japan had nothing to do with m2m – that was bad loans that were bad and they wouldn’t write-off – here we’re talking about good assets that are trading like bad assets because there is no liquidity in the market yet banks are being forced to mark these losses through their capital which is acting like a noose around their neck – relax the rule in this environment – nobody of consequence is considering suspending it, so I’m not really sure why the author is even arguing from that standpoint
March 20th, 2009 at 11:12 am
“the author’s whole premise is based on a misunderstanding of the facts – nobody is arguing for a suspension of mark-to-market”
Brian Westbury is on TV almost every day calling for MTM to be suspended. And there was someone on CNBC for an hour this morning calling for it to be suspended.
“Japan had nothing to do with m2m – that was bad loans that were bad and they wouldn’t write-off – here we’re talking about good assets that are trading like bad assets because there is no liquidity in the market”
So the US financial system has made no bad loans? I would argue against that point.
March 20th, 2009 at 8:45 pm
SanFranHobo – I don’t watch TV for my financial info – its just people there to entertain or to pushing their agenda – so you got me there – but you might note that I did tweak my second post to say ‘nobody of consequence’ to take into account there might be some fringe elements out there arguing for suspension
regarding the Japan comment – I think you misunderstood my point – the fact is that m2m is only for an issue for the securities held on bank books – so loans do not factor in any/this discussion which was about m2m/FAS 157
I was merely trying to point out that Japan’s problems were not a mark-to-market problem, but a loan problem
so I’d agree with your point – yes, the U.S. banks have made bad loans, but thats not what part one of this crisis was about – it was about securities losses and other related bad assets – bad *loans* are part 2, which is just starting as non-performing assets (credit card/auto/mortgage loans (not securities)) that are on bank balance sheets are rapidly rising
March 20th, 2009 at 10:26 pm
the site ate my homework again! – seriously, it disappeared again – so am posting it again – sorry if this is a dupe
mark-to-market was a big factor in US Central Credit Union failure – I don’t know the company that well, but they’ve been profitable – but their unrealized ‘fair value’ losses just became too big for them
– looks like about half their securities portfolio, or maybe 40% or so of their total assets, was invested in private-label MBS – about 25% of these private-label MBS were insured (AMBAC, MBIA, etc.)
– their profit for the first 9 months of 2008… $45 million
– total *unrealized* losses as of end of February… $6.6 billion! (total securities book – book value of $31 billion at 9/30/08)
- says the regulator who took them over/put them in conservatorship:
USFCC had “unacceptably high concentration of risk from mortgage-backed securities”
– rating currently showing on Moody’s website – A1, negative outlook
– I don’t have access to S&P right now to see what their rating was today before the failure, but as of 1/30/09, the rating was AA- (and I don’t think they had taken any action between then and now)
note that I’m not pointing out the ratings to bash the agencies, just to show that it looks like this was a bit of a surprise
says the company in its 3Q’08 quarterly report (which is the most recent one it filed):
“While the unrealized losses on U.S. Central’s investment securities portfolio reflect
decreases in the fair value of the securities, U.S. Central does not intend to sell the securities and
realize these paper losses. U.S. Central continues to believe that these unrealized losses will be
recovered over time as the securities pay off at par.”
says the company in its Feb. ’09 monthly performance report:
“Credit spreads widened further in February, particularly for non-agency
residential mortgage-backed securities. This widening was partly in response to
downgrades in that sector and caused the fair values of the affected securities to decrease.”
I believe S&P (and maybe Moody’s too) recently revised their loss assumptions for jumbo RMBS and other RMBS as well – that was what was behind the downgrades most likely
apparently the co. failed a ‘stress test’ and thus its regulator decided to take them over
note that they don’t serve the public, but serve as a kind of banker for the smaller local credit unions – service to member unions should remain uninterrupted according to a Bloomberg report
my primary sources:
http://www.uscentral.org/uploadedFiles/3QTR08%20SUPPLEMENT%20-%20Final.pdf
http://www.uscentral.org/uploadedFiles/USC%20February%202009%20financials.pdf
http://www.bloomberg.com/apps/news?pid=20601103&sid=aDuvFYn6_MFM&refer=news
March 20th, 2009 at 10:26 pm
testing testing
March 20th, 2009 at 10:41 pm
for anyone who cares, here is the regulators press release on the takeover of USCFCU:
http://www.ncua.gov/news/press_releases/2009/MR09-0320.htm
March 22nd, 2009 at 4:35 am
Wall Street apologists routinely declare that risk premia are excessive and that toxic asset prices are distressed, etc. Not so. There has been much fraud in mortgage origination and in pronouncements and financial statements from large financial institutions (e.g., Lehman debt paid off less than 10 cents on the dollar). The extent of these frauds keeps unfolding. Further, the deepest post WWII recession keeps deepening and housing prices continue to drop. It would be irrational to assume the contrary by valuing assets with historical patterns or simple adjustments to such historical patterns on mortgage payments or on bank financial statement reliability. An asset valued with realistic assessment of a distressed (and worsening) situation is not a distressed asset. It may, in fact, be over-valued by the market in terms of its realizable cash flows.
The only benefit of suspending MTM is increased opacity, to which only ostriches could rejoice. If they do by voting in the market on bank shares, there will subsequently be a large negative downward correction to those shares as the market reacts to the increased uncertainty. Increased risk premia will be the result.