FASB Discovers Own Cojones
Make that belatedly.
America’s previously neutered accountants — traditionally, green-visored chickenshit-cowards who have rolled over for their belly rubs from America’s CEOs and CFOs, giving them all of the bullshit they asked for over the past 2 decades — seem to be developing a spine of sorts.
Recall that in the midst of the credit crisis, the Accounting Standards Board were knuckled under by Congress. FASB now seems to be regretting their act of political cowardice. Here’s Jonathan Weil:
“Turns out America’s accounting poobahs have some fight in them after all. Call them crazy, or maybe just brave. The Financial Accounting Standards Board is girding for another brawl with the banking industry over mark-to-market accounting. And this time, it’s the FASB that has come out swinging.
It was only last April that the FASB caved to congressional pressure by passing emergency rule changes so that banks and insurance companies could keep long-term losses from crummy debt securities off their income statements.
Now the FASB says it may expand the use of fair-market values on corporate income statements and balance sheets in ways it never has before. Even loans would have to be carried on the balance sheet at fair value, under a preliminary decision reached July 15. The board might decide whether to issue a formal proposal on the matter as soon as next month.”
The mere fact these gutless wonders are even considering Fair Value accounting is a massive improvement. If the lobbyists and bought & paid for Congress don’t interfere, we may actually expect to see significant changes:
“The scope of the FASB’s initiative, which has received almost no attention in the press, is massive. All financial assets would have to be recorded at fair value on the balance sheet each quarter, under the board’s tentative plan.
This would mean an end to asset classifications such as held for investment, held to maturity and held for sale, along with their differing balance-sheet treatments. Most loans, for example, probably would be presented on the balance sheet at cost, with a line item below showing accumulated change in fair value, and then a net fair-value figure below that. For lenders, rule changes could mean faster recognition of loan losses, resulting in lower earnings and book values.
The board said financial instruments on the liabilities side of the balance sheet also would have to be recorded at fair-market values, though there could be exceptions for a company’s own debt or a bank’s customer deposits.”
That is a huge correction to a previous outrage.
Remember, mark to market accounting hasn’t caused these problems — It merely exposed them to bank investors.
>
Previously:
How Congress Betrayed Investors to Help Banks (April 3, 2009)
http://www.ritholtz.com/blog/2009/06/how-congress-betrayed-investors/
CDS/FASB (April 2nd, 2009)
http://www.ritholtz.com/blog/2009/04/cdsfasb/
What Does the FASB Proposal Mean for Financials? Evolution or Revolution? (March 18th 2009)
http://www.ritholtz.com/blog/2009/03/what-does-the-fasb-decision-mean-for-financials-evolution-or-revolution/
Sources:
Accountants Gain Courage to Stand Up to Bankers
Jonathan Weil
Bloomberg, July 23 2009
http://www.bloomberg.com/apps/news?pid=20601039&sid=a5BsXz90CMso
FASB Grows A Pair? Watch Those Stocks!
Karl Denniger
Market Ticker, July 23. 2009
http://market-ticker.denninger.net/archives/1255-FASB-Grows-A-Pair-Watch-Those-Stocks!.html
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July 24th, 2009 at 7:39 am
mark to market accounting hasn’t caused these problems
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Not sure what you mean exactly.
Mark-to-market is nice in theory but in practice, is a big headache.
There are alot of illiquid assets out there where you need to use an estimate.
And if you netted out all the derivative positions out there (a zero-sum game) thanks to accounting rules you get a net gain.
It’s going to take them at least a decade to dot the “i”s.
July 24th, 2009 at 7:46 am
danm is right about the problems with M2Market, but I’ve never understood why investors and depositors should have to rely on illiquid assets to ensure banks’ solvency. And remember, banks have typically abused M2Model accounting in order to skimp on capital requirements and thus achieve greater leverage (and profits).
As for the latest proposed changes, won’t these, like M2Market, reveal several of the large banks as insolvent? It will really be interesting to see how the government handles this, because Geithner, et al. have pretty much promised to NEVER, ever, resolve a large financial institution — no matter how much of my children’s children’s money it costs. We’ll see. I’ll believe it when I see it.
July 24th, 2009 at 7:48 am
Actually, there seems to be something even more interesting in the world of accounting than FASB’s cojones. I am referring to the intriguing possibility of upcoming fisticuffs between two different accounting standards bodies. Right before FASB came out with their new initiative, the IASB, its international parent/sibling, suggested the opposite. Specifically, as outlined here,
http://www.iasb.org/NR/rdonlyres/4483EDB9-CAE7-4119-A0FC-C243ECDF32D1/0/snapshot2.pdf
they are proposing that anything “bond-like”, i.e. where cashflows are contractually defined, effectively doesn’t have to be marked-to-market. This would imply that a very wide variety of ABS, for example, can be accounted for on what they call ‘amortised cost’ basis.
Exciting stuff!
July 24th, 2009 at 7:55 am
but I’ve never understood why investors and depositors should have to rely on illiquid assets to ensure banks’ solvency
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Banks are essentially made up of:
1. Residential mortgages
2. CRE
3. derivatives
Most of these are illiquid. So it’s only normal that the banks solvency is based on illiquid assets, that’s what a large % of their balance sheet is made of.
If the rules change, BB will just swap the unperforming assets for more cash before they get written down and the Fed’s balance sheet will grow faster.
July 24th, 2009 at 8:11 am
Talk is cheap, and actions rare. Just look at the history of Congressional investigations of the Crash of 1929 leading up to the Pecora commission in the 1930s:
http://en.wikipedia.org/wiki/Pecora_Commission
It is obvious that the Congress finally gave authority and power (probably more than they intended) only after the 3rd prosecutor resigned because they would not grant him subpoena power. Remember, this was before things like special prosecutors existed.
The FASB is just trying to regain some of the appearance of competence, which they completely shed in their earlier conduct. They likely remain confident that the Congress will not backtrack on their earlier actions.
I just hope they are wrong, and that we accidentally get some rules with teeth.
July 24th, 2009 at 8:12 am
Accountants, rating agencies, appraisers and maybe even regulators are all getting religion AFTER the train wreck. But if the World Bank is correct and we are only 1/2 way thru $4B writeoffs then is still plenty to battle about!
Any system that relies on estimated values of illiquid assets is a rubber crutch. Until there get these assets exchange traded the values are arguable ad infinitum
July 24th, 2009 at 8:14 am
If one cannot arrive at market values for assets, they should not allowed to be included in balance sheets.
Period.
July 24th, 2009 at 8:35 am
If one cannot arrive at market values for assets
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You go the bank to get an unsecured loan. You’ve got a great credit score so they give you the loan.
2 year down the road, you get divorced, your spouse gets all your money and you have a nervous breakdown. You lose your job and default on the loan.
The banker tries to call you but you don’t return the calls. Is this where you want the bank to take the loan off the books?
You go see a shrink, start getting better and go see your bank manager. You tell him/her you’re looking for a new job and things will get better.
Your banker renegotiates the loan but can’t decide whether you’ll make good on the loan or end up in the asylum and never pay a cent of it back.
So are you saying that the bank should have never lent you the money in the first place or that now that you are in default that they should just take it off the books?
July 24th, 2009 at 8:39 am
BR quoted
Now the FASB says it may expand the use of fair-market values on corporate income statements and balance sheets in ways it never has before.
reply:
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Evolution is a bitch. Depreciated historical cost is so old school. It’s soon going to be “what did it cost, how much of it have you used up, and what the hell is it really worth’? If you bought it then that means there’s a market for it so spill your guts. And don’t forget to the unrealized but economic gain or loss on the financials for all to see how good or crappy your managers really are. Both for the current period and the accumulated excellence or incompetence you have managed to accomplish.
But don’t bury it in ‘Other Comprehensive Income”, please. Nobody reads that shit or even understands it. Put it above the line or in a required pro forma statement that must accompany the basic financials.
It’s about time. Now maybe the AICPA will join the club and stress real life auditing on the CPA exam as a means to encourage real life auditors. Right now, you could lose a point on the exam if you don’t know the difference between a projection and a forecast and which does not require restricted distribution. That’s a hell of a skill to master. This kind of emphasis brings pointy headed thinkers into the profession.
July 24th, 2009 at 8:54 am
@danm 8:35 am
Yes.
July 24th, 2009 at 8:54 am
Right now, you could lose a point on the exam if you don’t know the difference between a projection and a forecast and which does not require restricted distribution. That’s a hell of a skill to master. This kind of emphasis brings pointy headed thinkers into the profession.
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Maybe that’s how you get the 15% unmeplyed back to work… train them as appraisers.
In a mark-to-market world we’re going to need a lot of them! And they’ll have to be just as qualifed as financial advisers if not more!
July 24th, 2009 at 9:03 am
danm Says:
July 24th, 2009 at 8:54 am
In a mark-to-market world we’re going to need a lot of them! And they’ll have to be just as qualifed as financial advisers if not more!
reply:
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The SEC doesn’t care about investors now and these rules won’t make a difference. What might have an effect is if auditors are told they will be the ones who go to jail if assets or income are overstated. Then you will see some kick ass valuations. Barney, do something about this.
July 24th, 2009 at 9:16 am
@Danm 8:54 pm
Let me be sure I understand you — are you saying that because we might not have the necessary numbers of qualified and competent appraisers, we should not attempt to portray the balance sheet assets in as realistic and factual way as possible?
If your local police department is a tad shy on the number of cruisers required to maintain their speed traps, should we just abandon enforcing speed limits?
And let me expand on my earlier response to your proposed loan situation –
1) IMHO, unsecured loans, regardless of credit rating (that should enter into the decision to grant the loan, but not in how it is reported) belong as, so long as they are maintaining the payments, tier 3 assets at best.
2) when the loan is in default, it becomes an asset with potential future value, but little or none at present — much like an option, where the value is dependent on the future. If I understand things correctly, options are not permitted to be included on balance sheets, at any value.
3) when an asset changes from having value to being unable to be included on a balance sheet, it should be written down. If it recovers and has value in the future, that can be reported as an exceptional line item.
July 24th, 2009 at 9:45 am
constantnormal:
I like the concept of m2m but I just don’t know how realitic it really is in practice. I don’t even think it’s a question of competence. I’d say character plays a bigger part.
During the housing bubble, I was surrounded by competent people who could not even imagine real estate prices ever going down. Obviously, these “mark-to-market” valuations on real estate (i.e. illiquid assets) were WRONG. If you are packaging these misvalued illiquid assets into liquid securities, don’t you just get garbage in, garbage out?
Our system is full of illiquid assets, that is why we created all these esoteric derivatives… to try and increase liquidity. But at the core of these valuations reside the real assets and you could throw your entire GDP into trying to figure out the right value for these, you will still need a crystal ball.
So my question is, how many bean counters do I want in my economy? Do I want more people who produce wealth and make the pie bigger or more middle people who take a slice of a smaller pie?
July 24th, 2009 at 10:11 am
Barry-
This is one of the best things I’ve seen you write:
“America’s previously neutered accountants — traditionally, green-visored chickenshit-cowards who have rolled over for their belly rubs from America’s CEOs and CFOs, giving them all of the bullshit they asked for over the past 2 decades — seem to be developing a spine of sorts.”
Thats just brilliant amigo. Brilliant!
And might I add that I think this may potentially be the biggest story I havent heard of yet- this is great news for people who actually want to own shares in banks- at least they can know what they own… IF… this all goes through…
which it wont of course… insert “bought and paid for congress” line… here.
July 24th, 2009 at 10:31 am
So much fictitious capital, just waiting for the tide to recede. The bankers association et al will fight this tooth and nail to prevent revealing they’re actually naked as they stand there waste deep in water. Citi, WFC,… adios
July 24th, 2009 at 11:06 am
danm, i don’t get where you’re coming from.
1) There’s a difference between reported results (which FASB governs) and capital requirements. The former are often used to inform the latter, but if you’re a bank holding assets you think are being undervalued by an illiquid market, you can make that argument to your regulator.
2) Capital requirements are pretty clear on held-for-portfolio whole loans. So using that as an example of “illiquid” assets is a pretty dumb example. Also, most publicly held banks don’t have a high percentage of their balance sheet composed of whole loans. Securitized assets and derivatives was where the game was.
3) The argument for allowing derivatives to be counted for purposes of bank capital was that they had a readily ascertainable market value. You can’t use cost accounting on derivatives, because there’s no underlying cost basis. So the only alternative to the market price is “mark to model”, which is notoriously variable, unreliable, and manipulable. So by eschewing fair value accounting, what you’re basically saying is that you want the banks to be able to use “mark to make believe” accounting. That’s bullshit and adds a ton of opacity to the picture.
4) I absolutely agree with you about the problems of M2M during a bubble. M2M was a major reason why banks loaded up on derivatives. However, getting rid of it now allows them to mark those derivatives at fictitiously high levels. There definitely needs to be M2M reform in the long run, but in the short run, suspending it simply serves the purposes of banks while screwing investors and taxpayers.
I’d also note that the claim that these derivatives are illiquid is also bullshit. Lehman’s derivatives cleared fairly easily. The holdup right now is on the seller side, and that’s because bank management doesn’t want to recognize the huge losses they’ve incurred. It’s the same reason why banks are rolling over unsustainable CRE loans. And the arguments for illiquidity over substantive losses (the markets aren’t working, everything is illiquid and driven by panic!”) are the same arguments we heard in 2007 with the SIVs (remember MLEC? That was supposed to solve the illiquidity problem with ABS) and subprime mortgage securities, the same arguments we heard in 2008 about jumbo mortgages, repo markets, etc. etc. etc. ad nauseum.
The banks are lying through their teeth. The illiquidity problem is driven by the fact that they are holding a bunch of shit and trying to sell it at gold prices. Once they sell it at fertilizer prices, the illiquidity problem will go away.
July 24th, 2009 at 11:12 am
@danm 9:45 am
I agree, but when it comes to the rules the system is run by, I prefer to be as inflexible and rigid as possible, instead of allowing large amounts of judgement and interpretation to enter into the metrics that we evaluate things by.
The judgement and interpretation will still take place, one cannot halt that, it’s a part of the difference between individuals. But having a rigid and inflexible system of reporting makes it possible for at least some of the people to not get fooled. All of the judgement and interpretation should take place in the mind of the consumer/investor, not in the factual presentation of the seller. It’s the difference between describing a fake brick veneer as “brick construction” vs “brick veneer”.
As things are, the old maxim attributed to Lincoln is wrong, we can fool all of the people all of the time — we just lie about it on the balance sheets. When the rules are demonstrably wrong, they should be fixed. But all things being equal, I prefer to have a system of financial reporting that I can rely on without having to second-guess whether they are legally cooking the books. At the moment, there isn’t a financial stock that you could persuade me to buy, because I don’t believe anything that they report represents reality. I’m sure that I am passing up some legitimate opportunities by thinking this way, but that’s my cost of dealing with crooks and liars in the financial industry.
The market value of real estate is notoriously difficult to arrive at, because each property is (usually) unique, in terms of the specifics of the property, its location, and the condition of the property and those around it. That’s why real estate appraisal is a highly skilled job. So we do the best job we can, using formulas involving sale prices of similar properties in the same or similar neighborhoods, and applying metrics like average neighborhood income and the relative standings of the particular property being evaluated against those recent sales being used to estimate its value. But allowing lenders to make up any story that makes their balance sheets shine is not the answer. So long as we have one methodology, that can be applied over the set of assets being evaluated, and is not subject to subjective assessments, I’m much happier believing in (or at least using) the numbers than otherwise.
July 24th, 2009 at 12:06 pm
“So by eschewing fair value accounting, what you’re basically saying is that you want the banks to be able to use “mark to make believe” accounting. That’s bullshit and adds a ton of opacity to the picture.”
I’m sorry but it’s always mark-to-make believe. When is the last time you bought a stock at it’s true intrinsic value?
Derivatives are based on underlying assets and these underlying assets need to be priced. The banks were putting loans on their books based on the apparaisals which were based on transaction prices. These were all wrong of course. I’m not crazy about marking-to-market stuff if the underlying stuff is not even priced properly either.
As soon as you put that loan on your books, the value has changed. So now tell me how frequently we need to write it up or down? I believe in mark-to-market I’m just not keen on the high frequency approach especially when the underlying asset is mispriced to begin with.
———————–
“There definitely needs to be M2M reform in the long run, but in the short run, suspending it simply serves the purposes of banks while screwing investors and taxpayers. ”
It’s all fine and dandy but who the heck was poing to reappraise these things QUICKLY and FAIRLY? The underlying assets are mispriced so how can the derivatives be valued correctly? I think it was quite logical to freeze it.
—————-
“I’d also note that the claim that these derivatives are illiquid is also bullshit.”
Maybe there is liquidity but does the value reflect the true long term value of underlying assets? What’s the use of mark-to-market if all you do is increase volatility and fire sales?
I also believe that the banks are lying throught their teeth but I also believe that if they truly wrote off all the bad stuff in one shot, we’d get armaggedon.
July 24th, 2009 at 1:11 pm
“When is the last time you bought a stock at it’s true intrinsic value?”
The only time you buy stocks at intrinsic value is when you are either picking thru the ruins of a chapter 10 bankruptcy, or if you are a dedicated Ben Graham investor, and buy only once a decade. Almost everyone buys using extrinsic valuations. But that does not mean that one should not be able to refer to or even know what the intrinsic valuations are.
I think you’re missing the point here. Nobody is suggesting that stock valuations be set to intrinsic levels, only that the book valuations reflect the current truth as best as it is able to be determined. That is, after all, the definition of book value. The difference between extrinsic and intrinsic valuations is the thing that makes horse races. Eliminating the knowledge of what the intrinsic values are makes investing not much different from fantasy football.
July 24th, 2009 at 1:19 pm
“I also believe that if they truly wrote off all the bad stuff in one shot, we’d get armaggedon.”
It would definitely be messy, but probably not armageddon. There are a lotta banks in this country, even more around the planet that would be happy to take over the actual business of the failed banksters. And fer sure there would be a lotta collateral damage in the pension, insurance, and related fields — that’s where the bailout money should have gone, as triage for collateral damage. But clearing out the toxic debt would put us well down the road to deleveraging, and would do so my destroying the people most deserving of that fate. Instead, doing things the way that we are, we spread the pain and hurt over everyone (except the guilty parties). That’s not the sort of action that strengthens a capitalist free-market economy, in the end.
And make no mistake — in the fullness of time, all “the bad” stuff is gonna turn into rotten pumpkins, as the terms of the various loans arrive and there is all this accrued unpaid balance and payments due. Sooner or later, they MUST write this junk off, as there is no way that they are going to make enough at the CDS roulette wheel to fill in the hole (grave) they have already dug for themselves. Odds are, they will only dig a larger grave to accommodate the rest of us in the process.
July 24th, 2009 at 1:34 pm
if we don’t use M2M (and i would guess free market supporters should be turning in their free market cards), then how do we value them? and how do we judge the values that a bank (or any company for that matter) put on it? we know that the management of a company have a large incentive to inflate the value of any asset, and deflate the value of any liability. and the rules for doing these should not be very flexible as that defeats the purpose. its like comparing the speed of 2 cars, only you change definition of miles per hour between them. other than watching them go how will you ever know which is fastest? the same problem appears in sales. if you sell a product/service, and you only report the value of it, how do you compare different years? after all, you could have one year where the price went up, and the next it declined say 50%.
July 24th, 2009 at 3:18 pm
only that the book valuations reflect the current truth as best as it is able to be determined.
——————
But that’s THE point… nobody can yet agree on what these houses are worth! You can argue that they are worth what you want until you sell it and realize the gain or loss.
Some think these assets will be bulldozered, others think immigrants will be buying them up like cupcakes in a few years. On top of that, many of these derivatives are made of pieces of assets that are mixed up like spaghetti noodles.
So OK let’s do it… Let’s reprice each house (on a quarterly basis) so we can reprice each loan (on a quarterly basis) so these MBS, CDO, derivatives can reflect fair market value. Most of you are already complaining that there are enough financial people, how many more do you want?
July 24th, 2009 at 3:20 pm
Sooner or later, they MUST write this junk off, as there is no way that they are going to make enough at the CDS rou
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Of course it will happen but I can bet my bottom dollar that the delay gives plenty of time for those in the know to properly postion themselves.
July 24th, 2009 at 3:26 pm
There are a lotta banks in this country, even more around the planet that would be happy to take over the actual business of the failed banksters. And fer sure there would be a lotta collateral damage in the pension, insurance, and related fields — that’s where the bailout money should have gone, as triage for collateral damage
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You are assuming that m2m would advantage the good guys.
When government stuck its nose in the financials and propped up the sector, it basically screwed up the entire derivatives market. Supposed winners are now probably losers and vice versa.
If m2m was forced on these supposed winners now turned losers, just imagine the screaming.
Our leaders aren’t as stupid as most would assume. They know whose butt they must cover.
July 24th, 2009 at 3:35 pm
@danm — I’m pretty sure that, given the mobility of the population nowadays, you can do this using the existing home sales data, which is undoubtedly in databases somewhere, and run it through a PC at the appropriate gummint agency that churns out those ridiculous statistics. Those numbers would not be accurate by any means, but they would be a lot closer than the way that the assets are being valued today, and it wouldn’t take any additional people or money to do so.
Personally, I’d prefer to spend a small amount of time and money after implementing such a scheme, and build a body of qualified and competent appraisers and auditors. It need not take an army — and after the initial wave of bankruptcies from the curtain being stripped away, there would be a lot less work for them to do — in fact, the remaining bnksters would be highly motivated to keep honest books in the first place, and would spend the time and effort to properly qualify loan applicants, properly evaluate the condition and value of collateral, etc.
The point here is not that the lenders are wanting to value their bum loans themselves, with each applying different stories to generate the valuations, it is that the banksters want to fraudulently represent their stock values in order to avoid sending the company into bankruptcy and losing their fat salaries and bonuses. This is *not* a victimless crime, the victims are the rest of us that keep sending bailout money and lax regulations to the banksters so they can continue in their malfeasance unimpeded.
July 24th, 2009 at 4:15 pm
[...] often overly compliant Financial Accounting Standards Board could actually be growing a spine and may recommend that financial instruments be recorded at fair market value and not [...]