Monday, October 13, 2008

A Simple(ton's) Answer?

"The answer seems simple. Mark-to-market accounting rules have turned a large problem into a humongous one. A vast majority of mortgages, corporate bonds, and structured debts are still performing. But because the market is frozen, the prices of these assets have fallen below their true value. ... Because the government has been so aggressive with the use of these capital regulations, private capital has been scared away. ... Nor would relaxing the mark-to-market rules temporarily in the U.S.--let's say for three years, for troubled assets issued between 2003 and 2007--undermine our standing internationally, as some allege", Brian Westbury (BW) at the WSJ, 1 October 2008.

"The [SEC] and the U.S. accounting-standard setter issued guidance that will allow companies to use more flexibility when valuing securities in a market that has dried up, a move the banking industry hopes will relieve pressure on company balance sheets. Tuesday, the SEC and [FASB] issued 'clarification' to accounting rules that require companies to value securities at the price for which they can be sold in the market, known a mark-to-market, or fair value, accounting. ... The clarifications allow executives to use their own financial models and judgment if no market exists or if assets are being sold only at fire-sale prices. They were welcomed by banking and financial-services groups that have lobbied the SEC. ... The SEC and FASB stopped short of bowing to pressure from some law makers and lobbyists who were seeking a complete suspension of fair-value-accounting", Kara Scannell at the WSJ, 1 October 2008.

"The American Bankers Association has been lobbying the SEC for leniency in applying accounting rules that require companies to mark financial instruments to their market price, known as fair value. In the current turmoil many of these mortgage-backed assets have been selling at distressed levels, and banks blame accounting rules they say force them to take bigger losses on these assets than warranted. Investors, auditors, and some large financial institutions including Goldman Sachs Group Inc. oppose suspending fair-value accounting, saying it only postpones reality. ... The SEC and [FASB], the U.S. accounting-standards setter, also aren't in favor of suspending fair value accounting for the same reason. But Tuesday, the SEC staff heeded calls by the banking lobbying and issued 'clarifications' to guide management and auditors in valuing financial instruments when the market for such assets has dried up. ... The risk remains that the guidance could give management too much wiggle room and result in assets with inflated or unrealistic valuations", Elizabeth Williamson and Kara Scannell (W&S) at the WSJ, 1 October 2008.

"The ostrich brigade is on the march. Some bankers, financial executives and members of Congress believe the financial crisis will abate if banks don't have to use market prices to value holdings. Put another way, if banks just pretend there isn't a problem, maybe there won't be one. ... The [SEC] and [FASB] also have come under pressure. ... Any move to abandon, or soften the impact of, mark-to-market accounting ignores the reality of the credit crunch. It was brought on by bad lending, coupled with insufficient capital. An accounting 'fix' won't change that. It may make matters worse. ... As Federal Reserve Chairman Ben Bernanke noted in Congressional testimony last week, eliminating mark-to-market acccounting could further undermine investor confidence. ... If Congress grants that wish, it will decree that investors should once again trust in the judgment of bankers who originated no-money-down, negative-amortization, pick-your-interest-rate mortgages. The lunatics will truly be running the asylum", David Reilly (DR) at the WSJ, 1 October 2008.

"Marking to market has become a commonly cited bugaboo, one many people blame for perpetuating the financial crisis. the SEC has tried yesterday to relax mark-to-market rules under pressure from its constituency. ... 'Accounting is a way of portioning economic results by time periods. It doesn't affect the cash flows, but tries to allocate economic profits proportional to release from risk. ... Mark-to-market accounting should play a role in valuating volatile financial instruments. ... Let the advocates of eliminating fair value explain why reducing information to investors is such a great benefit. ... In the absence of fair value, suspicion will take the place of information, and companies will still get marked down as failure takes place in fixed income assets classes.' ... what merkel is saying--and he knows, as suggestedby his earlier dissections--is that defaults in the underlying loan pools are real, and because of the leverage in the capital structure these securities really are deeply impaired", my emphasis, gaius marius (gm) at Decline and Fall of Western Civilization, 1 October 2008,

"Investor advocates say scrapping the rule now would encourage exactly the kind of shady accounting that defined the Enron era. Besides, when the real estate market was soaring a few years ago and mortgage asset values were spiking, no banks complained about having to use mark-to-market accounting, noted Edward Ketz, an associate professor of accounting at Pennsylvania State University", Marcy Gordon and Stephen Bernard at the Houston Chronicle, 2 October 2008.

"The banking industry and a band of lawmakers have used the scramble to salvage the financial-markets rescue plan to give new life to an industry push to avoid billions in further writedowns with the stroke of a regulatory pen. A proposal contained in the revised financial-rescue bill the Senate considered Wednesday reaffirms the [SEC's] authority to suspend 'mark-to-market' accounting. The language was meant to send a message to the agency to re-evaluate the issue. The practice, adopted in the aftermath of the savings-and-loan collapse of the 1980s, pegs the value of assets to their current market price, rather than the price paid for them. ... Critics of the proposed changes to the 'mark-to-market' rules say gains created by easing the rules would be illusory and would delay resolving genuine doubts about the value of mortgage assets that has caused the recent crisis in confidence. ... Financial-industry lobbyists' work on the financial-markets bill has given them another opportunity to press their case through their allies in Congress, many of whom are big recipients of campaign money from the industry. ... The Treasury, [Fed], accounting firms and some bankers say that divorcing the value of assets from their true market price can lead to an artificially rosy picture of a company's financial health. Inflated asset prices, they warn, helped contribute tothe S&L collapse in the U.S.--which inspired the mark-to-market rule--and a decade long economic slump in Japan in the 1990s. 'We have all seen what can happen when institutions are allowed to mask huge losses in asset values,' PriceWaterhouseCoopers LLC Chairman Dennis Nally wrote in a letter to Congress. Suspending the rules, he said, could 'plant the seeds for the next crisis'," my emphasis, Elizabeth Williamson and Kara Scannell at the WSJ, 2 October 2008.

"The [SEC] is telling chief financial officers that if they're estimating the value of troubled assets, they need to better explain what they're doing. ... As reported, the SEC also issued guidance last week to companies saying they needn't rely exclusively on market-prices. ... Some investors and accountants say the banks' real goal is to mask losses and postpone the pain. With its letters, the SEC is taking a middle course, suggesting the market price may be a poor indicator but companies need to justify using a different guidepost", Kara Scannell at the WSJ, 9 October 2008.

Is BW serious?

I went to the SEC's website to read the "clarification". It says little. Apparently Chris Cox (CC) does not want to be seen as having obviously bowed to industry pressure. What did I glean from the SEC's statement? That it wants CPAs to accept any management representation with respect to these assets. Well Mark Olson, what will the PCAOB do in its reviews of bank audits? Ask for documentation which does not exist? Will the PCAOB ask the SEC for a clarification of the "clarification"? Or will the PCAOB manage not to review any bank audit done by a Big 87654 firm? How does the PCAOB select its audits to review anyway? I now cite an old CPA joke. A Fortune 500 CFO wants to hire a new CPA firm. He calls up firm A and asks the prospective engagement partner (PEP) how much is two and two. He says four. The CFO says, "thank you". The CFO calls CPA firm B, speaks to the PEP and gets the same response. The third PEP says,"Whatever number you want it to be". The CFO says,"You're hired".

W&S see what's going on, but I go further. The purpose of the SEC's "clarification" is clear: to let banks overvalue assets.

DR rocks. I agree with Helicopter Ben on this. Amazing.

gm writes in lower case letters like ee cummings. Read the words I've emphasized and think about them. He cites David Merkel a CFA. I agree with Merkel who blogs at:

Ketz gets it.

W&S did well to bring up the 1980s S&L crisis. Bad accounting let it grow for years. In 1986 Congress, yes, those guys, held hearings about the CPA firms role in the S&L crisis. Correctly, Congress was critical of them. However, Congress never admitted that it encouraged the bad accounting the CPA firms let slide. I'm surprised Nally spoke so simply about this.

The SEC's goal is obvious: to faciliatate bad bank accounting.

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