What’s going on with MTM these days?
As the great mark-to-market debate winds down, it appears that pragmatism has overcome rule keeping zeal.
The strict reading of the rules has been deemed as too pro-cyclical, and the FASB bent to the Congressional timetable. It is a decision that was fair, consistent, on time and appropriate. It was also a decision in which neither side was completely satisfied with the outcome, which in many cases can be the sign of a good compromise.
Opponents of M2M demanded the use of a market price for non traded securities, claiming that it extinguished nuanced examination and removed the possibility of biased estimates. But in the end the FASB clarified the rules, recognizing that this “liquidation based” price method for illiquid assets contravenes accounting conventions that have traditionally been applied to other types of assets, such as plant and equipment.
This exact and inflexible application of the rule reminds me of the famous military logic of “Burning down the village to save it.”
Accounting should reflect economic activity, not drive it.
The latent complaints will ring in into the empty forum, but the debate is over.
Some bonds are worth what someone will pay for them. Liquid securities
Some bonds are worth what their economic value is. Illiquid securities
For illiquid bonds, the mark to market has two components.
An institution has to mark down immediately the loss on the security that is real, or caused by credit losses, directly to earnings and Tier 1 capital .
The part of the devaluation, or “loss” in a security that is caused by a lack of liquidity, is charged to “Other Comprehensive Income”.
This final ruling by the FASB is not a get out of jail free card. The loss components are explicit, stated and accounted for.
There can be no complaint mounted on a lack of transparency argument.
We will resume the debate once we have a few field examinations, and we find out how the clarified FASB instructions are being applied. We might end up back here, the debate back on.
Until then, we will continue to publish news and other regulatory updates.
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Berry’s Take on MTM
John Berry on Bloomberg posits the supporting argument for modification/ clarification of MTM. He makes a great point that separating the loss attributed to credit and the potential loss due to market illiquidity gives investors more transparency.
I think clarifying MTM to support the banking system generally, is worth the risk of some large banks gaming MTM specifically.
Please click here to read Mark-to-Market Rule Gives More Clarity, Not Less: John M. Berry
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Mr. Berg Goes to Washington
On Wednesday, Rich Berg testified as an expert witness before the United States House of Representatives, House Sub Committee on Banking. The subject of the hearing was informally titled, “Mixed Messages”. The Committee was inquiring about credit availability in the US banking system, and whether current regulatory or accounting structures were inhibiting lending.
The first panel called were representatives of the FED, OCC, OTS and SEC. Rich addressed the statement by Tim Long, Director of the OTS and his obervation that lending would not begin, until the securitization market was cured.
Watch Rich Berg’s testimony below.
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Arthur Leavitt Has This Backwards
In Leavitt’s article, Weakening A Market Watchdog, he gets it wrong. The FASB proposals will enhance disclosure and improve transparency by demonstrating the difference between the economic value and liquidation value.
Real dollars vs. accounting dollars.
Bob Herz didn’t back down, or change position. He reiterated existing policy. This is what he said:
Financial Accounting Standards Board Chairman Robert Herz defended the standards set by his independent body and suggested businesses weren’t applying them correctly. When markets dry up, management and auditors are permitted to use other factors, such as cash flow, to determine an asset’s value. They don’t have to rely solely on a price set in traded markets, Mr. Herz said. “The intent is to try to get a reasonable valuation,” he said. “I’m saying here on live public television: The standard allows for the exercise of appropriate judgment. I’m going to say that and say that again.”
I agree with Arthur Leavitt, however about the creeping politicization of the capital markets.
Market/ Government Regulators are supposed to keep a level playing field and punish rule breakers. They are not supposed to pick winners and losers, distort market price through the unintended consequence of well meaning regulation or be unwilling to change with market evolution.
By the way… There is momentum in DC for a “Global Risk Regulator”. We used to have that in the markets: It’s called “LOSS”. If you were bad at risk taking, you lost your money and were out.
We have a current environment where government is more involved than ever in the markets. Capital injections, first loss positions, conservatorship, cram down, servicer safe harbor are all current or proposed intrusions. I am not debating the merits of these programs, but they DO distort market signals.
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Congress Fuming after MTM Hearing
This article from CFO.com, Congress Members Fume at Fair Value, provides a clear summary of last week’s congressional hearing on fair-value accounting, emphasizing that Congressmen called for changes to mark-to-market rules, rather than an outright suspension of those rules. As most of us know by now, the meeting culminated in a promise from FASB to have some fair-value accounting rules guidance ready in three weeks. However, only time will tell whether this guidance will actually solve the issue or not. In the meantime, Representative Alan Grayson (D-FL) and FASB Chairman Robert Herz both believe that some institutions are waiting to write down damaging assets until potentially beneficial rule changes are enacted.
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More MTM Pain
This WSJ article on the FHLB provides a solid real-world example of how mark-to-market accounting has drastically affected banks. In the fourth quarter, the FHLB recorded a combined loss of $672 million-their first loss in about 20 years. This loss resulted from massive write-downs on mortgage securities that some home-loan banks had picked up in recent years in hopes of attaining higher yields.
Further obstacles may await home-loan banks with regards to their main business, which is making loans, or advances, to the commercial banks, credit unions, insurers, and thrifts that make up the home-loan banks’ membership. Banks’ demand for advances has gone down after receiving direct financial aid from the government, and this demand may decrease still further if the FDIC enacts a planned rule change that would require institutions with high dependence on advances to pay higher fees. Considering these complications, it seems further challenges are in store for home-loan banks.
Read this article that was in the WSJ yesterday: Mortagage Securities Drag FHLB to a Loss.
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McTeer testimony to the Financial Services Subcommittee
Former Dallas Fed Governor Robert McTeer’s testimony to the Financial Services Subcommittee on mark-to-market accounting:
MARK-TO-MARKET ACCOUNTING: Practices and Implications
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From THE Chairman from the FASB regarding “valuation”
Today, in a WSJ article, Regulators Draw Fire in Congress, Bob Herz, Chairman, suggests that preparers and auditors are not using enough flexibility in Level 3 pricing calculations…
Defenders of mark-to-market rules said it is the most-accurate way to put a value on a company, and weakening the principle would mask bad balance sheets and undermine confidence in the markets.
Financial Accounting Standards Board Chairman Robert Herz defended the standards set by his independent body and suggested businesses weren’t applying them correctly. When markets dry up, management and auditors are permitted to use other factors, such as cash flow, to determine an asset’s value. They don’t have to rely solely on a price set in traded markets, Mr. Herz said.
“The intent is to try to get a reasonable valuation,” he said. “I’m saying here on live public television: The standard allows for the exercise of appropriate judgment. I’m going to say that and say that again.”
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SEC Chair Promises to Fix MTM
SEC Chair Mary Shapiro promises a fix to MTM in Q2:
Mark-to-market accounting guidance due in Q2: SEC chief
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Buffett’s Problem & Solution
Holman Jenkins does it again in his article Buffett’s Unmentionable Bank Solution. He listened to Buffet and paid attention to the details. Warren described the problem and the solution: give the banks time to rebuild capital, instead of pouring real taxpayer cash into an accounting hole that government created.
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