NAPF: Mark-To-Market Inappropriate for Pension Plans

The National Association of Pension Funds (NAPF) recently warned companies that mark-to-market accounting for pension plans is “inappropriate.” Mark-to- market, says the NAPF, introduces unnecessary short-term volatility.

The counter to this volatility is extreme caution in investment policy and a reliance on low-return government bonds, both methods drive up pension plan costs, says the NAPF’s report.

“The current standards are not appropriate for the long-term nature of pensions. They allow short-term stock market volatility to perversely affect pensions and their long-term strategy by presenting large deficits which may prove inaccurate in the long run,” says NAPF chairman Lindsay Tomlinson.

United Kingdom-based NAPF follows the direction of the International Accounting Standards Board (IASB) while the United States follows the Financial Accounting Standards Board (FASB).

The two governing bodies have attempted to merge standards recently, with mark-to-market accounting being the main hot-button issue. Some notable United States companies, including Verizon, Honeywell, and AT&T, have made the switch to mark-to-market valuation of their pension plans, partially as a prediction that the FASB will adopt the IASB’s mark-to-market standards.

Study: Most Firms Use “Triggers” To Invoke Fair Value Procedures

In a recently released study by Interactive Data Corporation, mutual fund industry professionals continue to invoke fair value procedures at an increasing rate.

The survey, which covered 134 Chief Financial Officers, Chief Compliance Officers, and valuation team members, showed an increasing attention to market volatility as it relates to fair value accounting procedures.

“The heightened level of volatility in the market draws attention to the importance of fair value practices for mutual funds investing in international equities,” said Rob Haddad, director of Evaluated Services for Interactive Data. Haddad continued, “Our survey found that mutual funds are generally well-prepared for volatile market scenarios, with predefined fair value procedures in place to handle such events, and formal back-testing processes to examine how these procedures worked in practice.”

Among mutual funds, 36% reported that fair value is being applied every day, up from only 10% in 2004. The other 64% of funds reported using “triggers” — a process that pays attention to market movements and benchmarks — to apply fair value procedures for the fund. The strategy for triggers varied greatly in method, scope, and complexity, said the study.

Sapra: Increased Transparency May Not Be the Best Fix For Crisis

In a Bloomberg editorial, University of Chicago Booth School of Business professor Haresh Sapra says that conventional thinking on financial regulation may not be entirely beneficial. “The view that greater transparency enhances market discipline and therefore economic efficiency holds true only in a ‘Robinson Crusoe’ economy, that is to say one in which a single decision maker is learning about a company whose decisions are taken as given and whose future cash flows or economic fundamentals are therefore fixed,” says Sapra.

Fair value accounting is one method that regulators have undertaken to improve transparency, requiring that assets be accounted for at market price (rather than purchase price) to give a more accurate view of a holding’s value to both insiders and outsiders of a company. But financial insiders point to increased volatility in financial statements, leading to unnecessary and unintended instability.

The more that a financial institution relies on short-term pricing and value changes, the more at-risk it is for a “feedback loop,” as “decisions of financial institutions are more likely to be based on second-guessing of their competitors than on perceived fundamentals,” says Sapra. “Put differently, in trying to enhance market discipline, reliance on market prices via fair-value accounting weakens market discipline,” he concludes.

Amen to that, Professor! Let’s do both–print holdings at purchase price and then footnote the exact mark-to-market effect. This attains both goals–it gives long-term decision-making room to think and operate and fully discloses the market value effects on the institution. Why isn’t this a perfect solution? It provides more disclosure and less volatility–win-win!

Wright: Basel III Regulations Should Not Be Overlooked

The Basel III regulations, formed by the Basel Committee on Banking Supervision to overlook banks from an international perspective, are dangerously overlooked by many in the financial industry, says Ben Wright of Financial News. In response to the recession and credit crisis centered around 2008, new regulations from Basel III required that banks (and counterparties) adjust for potential losses against market prices as the risk of failure for a bank, company, or government increases.

This had astounding effects, says Wright. “The Basel Committee on Banking Supervision has calculated that two-thirds of the losses made on derivatives during the credit crisis came not from the default of counterparties but from the deterioration in their credit quality,” he says. Standard & Poor’s believes that of all the Basel committee’s actions, this requirement has “the greatest potential implications for the behavior of financial institutions in the medium term.”

These new rules were necessary because prior regulations ignored potential mark-to-market losses, says Wright. It was the timing and complexity of FAS 157 – the 2007 mark-to-market requirement – that ultimately caused undue stress for financial institutions in the United States.

“Often the regulatory response to one crisis sets the parameters for the next, says Wright. “All those governments poised to push through new financial regulations in the coming months should examine the example of new counterparty credit risk rules…and ask themselves whether now is the best time to field-test their unproven ideas,” Wright concludes.

Study: Mark-to-Market Accelerates Demise of Defined Benefit Pensions

Mark-to-market accounting is speeding the collapse of defined benefit pension plans according to a Leeds University study, reports Ellen Kelleher of the Financial Times. The issue of plan deficits arises after many defined benefit plans have invested in long-dated bonds instead of traditional equities, attempting to match the plan’s assets to its liabilities.

Mark-to-market accounting “has led to greater volatility in comprehensive income and the recognition of substantial and often volatile pension deficits in the statement of financial position,” said the study’s authors, Iain Clacher and Professor Peter Moizer. Mark-to-market has caused the decline in defined benefit plans “as corporate managers have increased the pace at which these schemes are closed to new members and to future accrual by existing members,” the authors continued.

In the United States, however, many pension plan administrators for large companies like Verizon and Honeywell have made the switch to mark-to-market for their pension plans. Analysts believe US companies have made the shift partially as a proactive move in the event that U.S. Generally Accepted Accounting Principles (GAAP) would begin to require mark-to-market in the near future. Many also point to the practice as a strategic move, allowing recession-hit pension plans to recognize losses in one year as opposed to smoothing losses over many years.

The ideal model, according to the study, would include the present value of future cash flows and cash payments by benefit plan administrators.

Economic Recovery at Two Years Running

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

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.

4th Quarter Earnings Almost Complete, Appear Strong

With 4th quarter financial reporting over 95% complete, reports appear to be strong from this earnings season. Zacks Investment Research has received reports from 479 firms and is awaiting the results from the straggling 5%. The investment research company noted that typically, the early-reporting firms perform much better than those filing reports last, but that the firms reported represent almost all of the potential earnings for 4th quarter. Thus, the remaining firms are not expected to have much of a negative effect on the overall earnings in 4th quarter.

Total net income has risen a very strong 29.6% versus the same quarter one year ago. Zacks points out that significant growth came from the financial sector, which posted huge net margins. The researchers did caution that the quality of the reports versus prior years can be subject to interpretation due to the absence of mark-to-market accounting. Much of the growth might be attributed to firms setting aside fewer reserves for bad debts compared to a year ago, said Zacks.

Mark-to-Market Debate Nears End of Discussion Period

The Financial Accounting Standards Board (FASB) proposed accounting rule changes have brought many dire predictions from its opponents, such as loss of jobs or a new banking crisis. This opposition has brought hundreds of comment letters to the FASB, ranging from personal investors to the powerful American Bankers Association (ABA). These comment letters are being accepted through the end of September, with a series of roundtable discussions to follow in October 2010.

The FASB rule change involves the expansion of mark-to-market accounting. Proponents say the expansion of this rule would give investors a clearer picture of a bank’s financial condition, by requiring financial institutions to value loans at market value, regardless of whether or not the bank intends to sell. Banks have opposed the rule changes, saying it would discourage new loans and thus hurt the economy. In a public comment letter, James Blaine, president of the State Employees’ Credit Union in Raleigh, North Carolina, calls the proposal “Theoretically arrogant; in practice insane.”

Opponents have also cheered the resignation of former FASB chairman Robert Herz, a vocal proponent of the rule change. While his temporary replacement at the helm of the FASB, board member Leslie Seidman, has voted against the proposal, the FASB’s newest board member, Russell Golden, has not made his position known.

Former Federal Reserve Chairman Paul Volcker Talks Mark-To-Market

Paul Volcker, former Chairman of the Federal Reserve and current Chairman of President Obama’s Economic Recovery Advisory Board recently discussed current financial regulation with Steve Forbes in an interview for Forbes.com. Volcker expressed his opinion (congruent with many other financial experts) that this particular recession is atypical and that standard means of recovery will not suffice. He went on to say that the current financial regulations, many of which he has worked on with the Economic Recovery Advisory Board, are not the final answer, but rather “a definitive step in the right direction.”

Recently proposed changes by the Financial Accounting Standards Board (FASB) have drawn Volcker’s concern as well. In the interview, he says “…my impression is just that FASB is much more toward insisting upon mark-to-market accounting in areas that I don’t think it’s appropriate.”

Volcker also speaks about critics’ claims that his famous “Volcker Rule” – designed to curtail proprietary trading by commercial banks – is being watered down, despite claims by the author himself that it will last.

The entire interview is available on Forbes’ Intelligent Investing website: http://www.forbes.com/intelligentinvesting.

I think we should listen to Volcker. The guy was present, and active, during the last major economic crisis.

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