Mark-to-Market Debate » General

Ford: University Endowments Using Shaky Financial Strategy

admin — Tue, 16 Aug 2011 11:12:37 +0000

Investor George W. Ford, in an editorial to American Thinker, discussed the “recklessness” of Princeton and other universities’ endowment fund management. He noted that many universities of this stature have adopted the “Yale model”: emphasizing “alternative investments” and leveraging these bets that asset values would continue to rise at a brisk pace. The problem, as Ford says, is that portfolios can turn illiquid in a market downturn, which has dropped the value of university endowment portfolios nationwide.

The trouble comes in, says Ford, in an imbalance like Princeton’s, which invested 82% of its portfolio in a category called “Level 3 – Significant Unobservable Inputs.” (Level 2 shares are assets like Treasury bonds – not actively traded but easily measured. Level 1 inputs are market assets, liquid and easy to measure.)

The Financial Accounting Standards Board (FASB) defines a Level 3 asset as something illiquid with little certainty about the valuation. All assets for university portfolios must apply fair value accounting, per Ford’s research into the FASB governing rules.

The issue with this “Yale model” adopted by so many institutions is that these “unobservable” inputs could vary widely if sold today – perhaps not at the perceived market value that the endowment fund managers place on these illiquid assets. “Many jokes could be told about how the brilliant minds at Princeton use “unobservable” inputs to calculate a net endowment value of $14.4 billion while not being able to park their bicycles straight,” says Ford.

Quantitative Easing and Mark-to-Market a Concern for Economists

admin — Thu, 07 Jul 2011 16:05:39 +0000

In a recent New York conference, Nobel Laureate Robert Mundell, widely regarded as the “monetary guru” of conservative economists, spoke about quantitative easing and the recovery from the global financial crisis. Mundell surprised many when he said that deflation, not inflation, should be the greatest concern to the United States economy.

His comments relate to a discussion on the Fed’s reaction to the financial slump. Mr. Mundell said that the Federal Reserve’s decision to implement mark-to-market accounting in the midst of the subprime mortgage crisis is “one of the worst mistakes in its history.” Mark-to-market forced financial firms to cover short-term losses, a key component in the overall health of the bank. Mundell says this implementation exacerbated the problem, rather than eradicated it. The first bout of quantitative easing, which lowered the dollar against the euro, gave the economy it’s first sign of recovery, he said. But QE2, which lowered the value of the dollar and allowed the second leg of recovery to begin, was the wrong solution, he says.

Economic Recovery at Two Years Running

admin — Tue, 14 Jun 2011 15:55:09 +0000

It has been over two years since the United States financial market bottomed out on March 9th, 2009. Financial publication The Street reported on the financial regulation and gains that have led to this recovery.

The very first catalyst noted by The Street is the repeal of mark-to-market accounting rules. As banks lend based on the value of their reserves, lending was difficult as debt prices plummeted. Though often criticized for allowing banks, not the market, to determine the financial worth of their debt reserves, mark-to-market’s repeal has been noted as a key factor to the recovery, as banks could now lend freely.

Though mark-to-market’s repeal was only part of the recovery, as bank balance sheets were still struggling a year after the bottom-out. Federal Reserve Chairman Ben Bernanke’s Quantitative Easing programs, where the Fed would purchase Treasury bonds to pump more money into the economy, is the key follow-up to the recovery noted by The Street.

Regulators, Politicians Battle for Economic Recovery Credit

admin — Tue, 07 Jun 2011 15:53:03 +0000

With a political shift in Congress and the economic recovery beginning, many have now tried to seize political points by claiming responsibility for the United States’ current financial upswing. A Seeking Alpha editorial by Brian Wesbury profiles this debate, saying that while certain elements of the recovery can be attributed to different areas, it has been entrepreneurs that provided the backbone to the recovery.

Wesbury criticizes Federal Reserve Chairman Ben Bernanke for his politicizing. Bernanke pointed to Quantitative Easing on the part of the Federal Reserve as a key factor in the recent recovery. Wesbury notes that the first round of Quantitative Easing began in September 2008, well before the market bottomed. “When mark-to-market accounting was changed to allow cash flow, instead of illiquid market prices to be used to value assets, the equity market bottomed. Once the accounting rule was ‘fixed,’ any risk of a Depression vanished and the economy started to recover,” says Wesbury. He continues to note that the 2004 interest rate drop (to 1%) exacerbated the over-investment in housing, which “never would have created a financial crisis if mark-to-market accounting had not been instituted in November 2007.”

Overall, Wesbury argues, it was political dealings that helped cause the crisis, but the American entrepreneur who really deserves credit for the recovery.

Mark to Market Will Wreak Havoc on Small Businesses

admin — Wed, 20 Oct 2010 12:00:25 +0000

In a commentary for Forbes Magazine, former Federal Deposit Insurance Corporation chairman William M. Isaac called for congressional oversight of the Financial Accounting Standards Board (FASB) because their proposal to extend mark-to-market accounting rules will create havoc in bank lending to small businesses.

Isaac, who currently serves as chairman of LECG Global Financial Services, said that banks will be constrained to lending short-term loans to only the highest quality borrowers and that a “five-year loan to the owner of the local restaurant…will be a thing of the past.” Market values for loans of this type would fluctuate too much, thus prohibiting banks from taking the risk on longer-term commitments.

Ultimately, Isaac feels that market-to-market is detrimental to the economy because it “obscures…economic reality and financial performance” and that the FASB’s proposals will result in “profoundly negative implications for employment and economic growth.” Let’s listen to Bill Isaac. He has been a regulator and a lender. We can leave something this important to Congressmen and accountants.

Ex-FDIC Head Calls FASB Plan “Destructive”

admin — Fri, 17 Sep 2010 12:00:11 +0000

In a telephone interview with Bloomberg Businessweek, William Isaac commented on the proposed Financial Accounting Standards Board (FASB) mark-to-market accounting rules. These would require banks to report both the fair value and amortized cost of loans and some other financial assets and liabilities on their balance sheets.
“This is a terribly destructive idea to even propose,” said Isaac. He believes that simply by making the proposal, the FASB will cause banks to quit making loans that do not have a clear market value and keep those whose value can be easily discerned to shorter maturities.
Isaac contends that mark-to-market accounting destroyed $500 billion of bank capital as traders marked down all assets during the crisis by a total of 27 percent. Only recently have many of those values returned to near par. “Now FASB is going to spread this disease throughout the system,” he said.
Bill Isaac is right. He has been on both sides of this fence. We should listen to him.

Kanjorski Changes Position On Mark to Market.

admin — Fri, 10 Sep 2010 12:00:02 +0000

Paul Kanjorski (D-PA), chairman of a subcommittee of the House Financial Services Committee, came out strongly opposed to mark to market accounting in a March 2009 hearing he conducted. At that time he complained:
The magic of mark to market accounting required this relatively minor shortfall to be treated as an other-than-temporary-impairment loss of $87.3 million. I find that accounting result to be absurd. It fails to reflect economic reality. We must correct the rules to prevent such gross distortions.
In a recent press release announcing new hearings to assess accounting rules and a lack of transparency in financial reporting, Mr. Kanjorski appears to have modified his position:
“…We must ensure that accounting and auditing standards respond to the needs of investors by producing timely and accurate assessments of a company’s financial situation. This hearing will enable Congress to review the current accounting and auditing standards that apply to participants in our financial markets and discuss how we can improve them in the future.” (Emphasis added.)
I agree and disagree. Accounting should reflect the economics, not drive them. This isn’t either/or. Let’s report the fair value by informing investors in the footnotes.

Italy Suspends Mark-To-Market Accounting on Government Bonds

admin — Wed, 08 Sep 2010 12:00:13 +0000

The Bank of Italy has announced that Italian lenders holding European government bonds in their available-for-sale portfolio no longer need to take into account possible capital gains or losses.
“Count Bank of Italy’s decision to allow banks holding European government bonds in AFS portfolios to suspend mark-to-market accounting rules as the latest iteration of unintended consequences,” said Jeffrey Rosenberg, head of global credit strategy research for Bank of America Merrill Lynch. “By suspending the rules, inadvertently market uncertainty increases as confidence over the value of the holdings, exposures and hence capitalization erodes.”
Italy’s decision aligns with those of European nations such as France and Germany that have already suspended fair value accounting requirements.

IASB Responds to Criticism Over Mark to Market Accounting

admin — Wed, 01 Sep 2010 12:00:54 +0000

In response to criticism about the effects of fair value accounting, the International Accounting Standards Board (IASB) has made public its proposed changes to the accounting standard for financial liabilities.
Should the proposal be approved, all gains and losses resulting from changes in “own credit” for financial liabilities that an entity chooses to measure at fair value would be transferred to “other comprehensive income.”
“Whilst there are theoretical arguments for treating financial assets and liabilities in the same way, it is hard to defend the accounting as providing useful information when a company suffering deterioration in credit quality is able to book a corresponding large profit,” said Sir David Tweedie, Chairman of the IASB. “Especially when investors tell us that such information is often excluded from their financial models.”

Silicon Economics Sues the FASB

admin — Mon, 30 Aug 2010 12:00:05 +0000

Economics, Inc. (SEI) has filed a lawsuit in a federal district court against the U.S. Financial Accounting Standards Board (FASB), charging it with antitrust violations and willfully attempting to misappropriate patented technology belonging to the company. The suit concerns Silicon Economics’ EarningsPower Accounting™ (EPA) method, a solution designed to address the inadequacies of mark-to-market accounting.
SEI had submitted their EPA method in response to FASB’s request for public comment on the objectives of financial accounting. FASB had subsequently laid ownership claims to the technology, defending it as fair game under the terms disclosed on their website. SEI denies being informed of those rules.
“FASB’s unlawful attempt to appropriate SEI’s intellectual property undermines innovation and competition, and harms the U.S. economy,” said SEI’s Attorney Perry J. Narancic. “SEI will defend its intellectual property vigorously.”