Thursday, July 17, 2008
Schwartzman and McTeer on Accounting
"Some blame the rapacious lenders. Others point to the deadbeat borrowers. But Stephen A. Schwartzman [SS] sees another set of culprits behind all the pain in the financial industry: the accountants. That's right, the bean counters. ... Schwartzman is convinced that the rule--known as FAS 157--is forcing bookkeepers to overstate the problems at the nation's largest banks. ... Some of his bigwig pals in finance believe that Wall Street is in much better shape than the balance sheets suggest, Mr. Schwarztman said. The president of Blackstone, Hamilton E. James, goes even further, FAS 157, he said, is not just misleading: 'It's dangerous.' Huh? So the Citigroups and Merrill Lynches of the world are writing off billions of dollars--but they haven't actually lost the money? ... FAS 157 represents the so-called fair value rule put into effect by the Federal Accounting Standards Board, the bookkeeping rule makers. It requires that certain assets held by financial companies, including tricky investments linked to mortgages and other kinds of debt, be marked to market. In other words, you have to value the assets at the price you could get for them if you sold them right now on the open market. ... The rule forces banks to mark to market, rather than some theoretical price evaluated by a computer--a system often derided as 'mark to make-believe' ... But here's the problem: Sometimes, there is is no market--not for toxic investments like collateralized debt obligations or C.D.O.'s, filled with subprime mortgages. No one will touch this stiff. And if there's is no market, FAS 157 says, a bank must mark the investment's value down, possibly all the way to zero ... Schwartman and others say FAS 157 is forcing underserved [sic] write-offs and wreaking havoc on the financial system. There is even a campaign afoot in Washington to change the rule. ... Bob Traficanti, head of accounting policy and deputy comptroller at Citigroup, said at a conference last month, that the bank had 'securities with little or no credit deterioration, and we're being forced to mark those down to values that we think are unrealistically low.' ... According to the [SEC], FAS 157 requires an institution to 'to consider actual market prices, or observable inputs, even when the market is less liquid than historical market volumes, unless those prices are the result of a forced liquidation or distress sale. '' ... Schwartzman's theory only holds up if the underlying assets are really worth much more than anyone currently expects. And if they are so mispriced, why isn't some vulture investor--or Mr. Schwartzman --buying up C.D.O.s en masse? For Mr. Schwartzman's part, he says that the banks haven't been willing to unload the investments at the distressed prices. Besides, the diligence required for most buyers is almost too complicated. ... The folks at the University of Chicago--those the-market-is-always-right guys--take umbrage at the mere suggestion that marking-to-market is not always appropriate. ... 'He's entitled to his view, but I don't agree' said Daniel Alpert, managing director of the investment bank Westwood Capital. 'I don't believe that people are taking writedowns that forces them to dilute their shareholders.' If anything, Mr. Alpert says, 'There is still a lot of sludge out there.' ... But some say Goldman Sachs proved why FAS 157 works: Goldman has been marking its books to market for years, and as a result, its risk officers were able to hold back its go-go traders from making bad bets when everyone else was throwing down their chips last year into the subprime game", my emphasis, Andrew Sorkin (AS) at the NYT, 1 July 2008, www.nytimes.com/2008/07/01/business/01sorkin.html?ref=business.
"To me, the most serious example of doing the right thing at the wrong time is overy strict adherence to 'mark to market' accounting rules. Most of the write-downs of securities that are creating capital shortages in financial institutions don't result from actual losses, or even expected losses. They result from having to mark down assets, many or most of which could be held to maturity and redeemed at par. ... Moreover, identfying [assets] that can easily be held to maturity, and classifying them as such, makes more sense than marking them down to levels that never need be realized. ... While mine is no doubt a minority view, it is supported by William Isaac, former chairman of the [FDIC]. ... Accounting purists would call this forbearance and frown. But forbearance in shooting the sick and wounded with good recovery prospects is no sin in my book", my emphasis, Bob McTeer (BM) at the WSJ, 5 July 2008.
I largely agree with AS, but believe his errs in writing, SS "is convinced". It would be correct to say, "Schwartman said", from which I conclude it is in SS's interest to replace SFAS 157. Who are these "bigwig pals"? Who or what is FAS 157 dangerous to, Hamilton? Your personal interests? Hey Bob Traficanti (BT), does "C" make margin loans? Does "C' mark margin loan collateral "to market"? Would "C' make IA a loan on collateral for which I state a value based on Yuri Yoshizawa (YY) at Moody's values? Well? BT, if you know "C" has assets worth more than their recorded values, give up your sinecure at "C" and buy them with your own money. Otherwise, shut up. Do you, a former FASB employee remember the SFAS 15 accounting nightmare of "troubled debt" restructurings? BT, I have another idea for you and your superiors: value the assets in question at any amount you want. However, have "C" schedule them on a new SEC form, I'll call IA-3. IA-3 lists the assets cost, market and accounting values. IA-3 must be updated quarterly. At the end of five years, all IA-3 assets, not yet sold are sold. If the total proceeds of the asset sales are less than say 90% of the original accounting values, all IA-3 preparers enter guilty pleas to securities fraud. How about it? Alternatively, you BT, "C's" resident genius, buy any scheduled asset within 30 days of IA-3's filing for 75% of the scheduled amount. Well, BT, howaboudit? A suggestion for "C": let "C" voluntarily disclose all this info on a Form 8-K. C'mon tough guy, show us some stones. Why was Craig Giles prosecuted? No market, at what price? How will SS distinguish between deserved and undeserved write-offs? Consult Ed McMahon's hermetically sealed mayonaisse jar? How does BT know the securities had "little or no credit deterioration"? Did he ask YY? Will "C" offer say $1 billion of its least valuable, in BT's eyes CDOs to say Sam Zell for $10 million? $20 million? How much?
I go further than I did on 7 July 2008, Vikram Pandit, give BT an ultimatum: buy the assets he thinks are undervalued or have "C" give his a year's severance pay and out the door. Heck, "C's" directors should give you the same ultimatum. Or else disclaim BT's position.
What's SS's beef? He must be finding it more difficult to secure leverage buyout financing which is now marked to market. How did LBO companies like Blackstone make their money? From capital market inefficiencies. The banks systematically underpriced LBO loans to the detriment of bank shareholders and benefit of LBO sponsors. Did most LBO profits come from billiant managerial decisions? Operating and financing decisions are separable. Anything operating change the pre-LBO company could have made, it could have made without the LBO. Where's the profit? Extracted from the backs of bank shareholders and bondholders. You do some LBOs, some win some lose. The losers wind up in bankruptcy court. Who cares? "Call options" expire all the time.
BM's comments are so rich, where to start? Writedowns create capital shortages? How? BM, do you remember the S&L crisis, or was that before your time? You are about 67, so should remember it. We heard the same accounting arguments then. Call me an accounting purist. Ad hominem attack. So? BM, when would be a good time to implement the rules? Did large financial institution mangements learn nothing from the S&L crisis? As to holding assets "to maturity and redemeed at par", I have an idea: I'll buy 30-year Treasuries, like the 4 3/8 due February 2038, currently at 97 14/32 and see if you'll buy them from me at par. Even better, the February 2038 zero currently at 26 8/32. How does BM know what "levels ... never need be realized"? If BM, does, shut up and join SS's vulture fund. BM is a "former president of the Federal Reserve Bank of Dallas". My conclusion: Helicopter Ben et. al., encouraged BM to write this. Further, the big banks have tens of billions more in writedowns to come.