Mark to Market Leads to Greater Investment From Overseas
The Financial Times reports that tougher regulation and the push for mark-to-market accounting have caused domestic pension fund managers to shift away from equities and other riskier investments. Because populations are growing older, this migration was inevitable. However it was anticipated to occur at a more moderate pace.
For example, in the UK, domestic pension funds and life assurers have reduced their share of the UK equity market to 25-30 percent. In the U.S. the pool of pension money is so vast, it takes very little diversification by Americans to have a big impact on the securities market.
The question is whether the shift to bonds is significant. Foreign investors are moving into securities as domestic investors leave. There is reason to be concerned when a country becomes heavily dependent on foreign equity flows: Overseas investors tend to be less committed owners than domestic institutions, and foreign investors are more likely to move in a herd. The Financial Times worries, “When they make for the exit, it can be destabilising [sic] for currencies as well as stock markets.”
Regulations have consequences. Let’s keep this in mind as we reconfigure the U.S. markets.
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FASB Fights to Restore Mark to Market
J.P Morgan Chase, Bank of America, Citigroup and Wells Fargo are aligned in opposition to the Federal Accounting Standards Board (FASB) proposal. Approximately $2.8 trillion of their loans could be affected, or about 40 percent of their total assets. The impact would be even greater on smaller banks that keep more of their assets in loans that aren’t marked to market.
Pressure for the change is coming from Congress’s belief that the FASB watered down mark-to-market rules and these loose rules contributed to the financial crisis. Banks were not required to pay sufficient attention to market value in the time leading up to the crisis, estimated losses were inadequate, and banks were unprepared for the credit crunch.
On the other hand, many bankers and bank regulators believe the rules exacerbated the crisis by causing the value of some loans to fall excessively.
Under the FASB proposals, banks would show loans at historical cost and then adjust them for both loan-loss reserves and market values so investors could see the gap between what management has held for losses and what investors may believe the loans are actually worth.
The second proposal would require banks to divide holdings between those they trade and those they hold. Tradable assets would affect profit immediately. Non-trading assets would also be marked to market but would be categorized as shareholder equity called, “comprehensive income.” Mark-to-market is pro-cyclical. It should be used on liquid, available for sale assets only, and marked to their “economic” value, not “market” value.
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GASB Considering Shift To Mark-To-Market Accounting
The Governmental Accounting Standards Board (GASB), which establishes standards for state and local governmental accounting and financial reporting, is considering a policy shift to mark-to-market accounting procedures.
Whereas GASB’s current standards values assets over the long term, they would instead be revalued daily based on market values.
Concerns have been raised that the new policy would unnecessarily call into question whether some public pensions are fully funded. Applying mark-to-market accounting could drop an otherwise 90 percent funded pension to 80 percent, 70 percent or even 60 percent. It depends on the market and each fund’s overall financial situation.
Pensions that are 80 percent funded or below are considered unhealthy. Does it make any sense to substitute a daily market price to a long term economic value (cashflow)? We are as aware of how woefully underfunded public pensions are. The least of the problems are how the assets are accounted for. This pours salt into the wound for no good effect.
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Bernake Anticipates Upcoming Refinancing Cycle
Filed under: Federal Home Loan Banks, Market News, Real Estate
Federal Reserve Chairman Ben Bernacke noted recently that commercial real estate loans will soon need to be restructured. It is expected that the peak activity will occur in Q2 2012.
To mitigate the possible crisis that could result when property values and debt no longer square — or possibly never did given the lax approval processes that preceded the financial collapse — Bernake urged that cash flow analysis be paramount in developing restructured deals. As Bernanke explained, “Commercial real estate loans should not be marked down because the collateral value has declined. It depends on the income from the property, not the collateral value.”
Bank regulators have not yet publically agreed to using cash flow instead of marked to mark collateral values for determining the value of these loans to be restructured. It is anticipated that they will.
Ben finally gets it. It’s the economic value that matters, not liquidation price. Let’s hope all of the other regulators get the memo and apply. Ben’s prudent proclamation to residential real estate, too.
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So This is News…
[$$] Banks Face Mark-to-Market Challenge – Wall Street Journal, March 15, 2010
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New Study Says Mark-to-Market Not to Blame
A new study published by the Federal Reserve Bank of Boston says that mark-to-market accounting had only a minor impact on large financial institutions during the financial crisis.
Sanders Shaffer, Director of Accounting Policy and Analysis at the Boston Fed maintains that:
Capital destruction was due to deterioration in loan portfolios and was further depleted by items such as proprietary trading losses and common stock dividends. These are a result of lending practices and the actions of bank management, not accounting rules.
Mr. Shaffer, who studied banks with at least $100 billion in assets, did not find any evidence that mark-to-market rules drove banks to sell assets at distressed prices. Instead, to raise the capital they desperately needed, institutions mostly tapped government programs and the debt and equity markets.
For most banks in the sample, fair value adjustments had only a small percentage impact on regulatory capital. Mr. Shaffer did not ascertain any link between fair value and capital destruction.
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If You’re “Too Big To Fail” Are You Too Big?
It’s a question that has aligned an interesting mix of people. As impossible as it might seem, everyone from House and Senate Republicans to the AFL-CIO, Ralph Nader, and Democrats of virtually every stripe agree that the answer is a resounding, “yes.”
Admittedly, liberals and conservatives have their own reasons for drawing the same conclusion, but they agree that Citigroup, Bank of America, JPMorgan Chase, and others that are too big. And the sentiment is shared on the other side of the Atlantic as well. European politicians are pushing for the break-ups of ING, KBC and Lloyds.
The bankers are understandably not so keen on the idea of being broken up. They do present the valid argument that their size makes them a powerful force in the world market. If forced to break up, they maintain, banks in countries that are not forced to downsize (Possibly themselves after they move?) will have the advantage.
The option to a break up is more regulation — so much regulation, in fact, that these banks would function as quasi-public institutions like AIG, Fannie Mae or Freddie Mac.
So what will happen? That’s easy. When you have two unpleasant options and banks pushing millions into campaign coffers to keep the status quo, all the consensus in the world is useless. Not only will nothing happen, these mega banks will have less incentive than ever to avoid staggering risks … because they’re “too big to fail.”
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Dollar Daze
Every administration has pledged to hold our currency strong since Nixon devalued the dollar in 1971. Since the Euro was introduced only ten years ago, the dollar has lost more than 50%. During the same period of time, the dollar is down almost 25% against the Yen.
The inconvenience of more expensive European vacations aside, the precipitous slide is something that needs to be stopped. The idea that a weak dollar is good for American exporters is a fallacy. Except for agricultural commodities, we export virtually nothing. All a weak dollar will do is exacerbate our trade deficit, bring on inflation, lead foreigners to sell off US investments, and make it more difficult to pay down our debt.
A weaker dollar devalues everything — our assets, our incomes, and particularly our nation’s role as the preeminent economy. The dollar is still the reserve currency for investors, but the pace at which it is falling means it will be only a matter of time until the Euro has the critical mass, or investors start to become comfortable with a communist Yuan, and the dollar will lose its position as the world’s currency of choice. Every administration has pledged to hold our currency strong since Nixon devalued the dollar in 1971.
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Is Everybody Happy?
The mark to market debate doesn’t need to be winner-takes-all. We can create a system that will satisfy the FASB and investors.
Assets and liabilities can both be held at cost on the balance sheet while current market value is disclosed. Investors will get the fair value number they need to determine current shareholder value, and the FASB gets their market value. Maybe we also disclose a weighted average rate and term for bonds, loans and the like. We can even post the margin based on fair value.
Well, maybe the FASB will be happy. The critical piece is that assets need to be held at cost. The balance of the information is simply disclosed.
No matter how fishy mark to market prices may be, there is no mistaking it. They do force real world investment and credit decisions that have painful and unnecessary consequences. When mark-to-market losses reach “stop loss” levels, solid AAA-rated securities are dumped at steep discounts for accounting reasons that are purely contrived.
Good for the guy who buys the assets, of course. Not so good for the guy forced to sell. And the FASB is smug in its thinking that they have done the world a service. Let’s make everyone happy instead.
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Sunny Days Will Return
Say what you want about the deposed junk bond peddler at Drexel Burnham Lambert, Michael Milken, you have to admit that he’s right on this one. He once noted, “Liquidity is an illusion. It is always there when you don’t need it and rarely there when you do.”
To elaborate, in volatile times, money moves toward rock-solid investments. Specifically the Federal Government (Have you seen the short-term Treasuries recently?). In more stable times it moves toward investments that deliver a better return.
The last year or so can hardly be called stable. Predictably, money fled the markets, depressing the value of everything. When compounded by the housing collapse and the problems that rating agencies have had assessing bonds, long-term assets held to mark to market accounting rules got hammered.
But these are all temporary events that are impacting long-term investments in the short-term. Nonetheless these are the criteria mark to market uses to evaluate an investment. It’s a bit like valuing the convertible you bought yesterday at 10% of its purchase price because it’s raining today.
There will again be a sunny day. And as bizarre as it sounds, the FASB should take advice from Mr. Milken. Liquidity will return. When we need it least, of course, but it will return nevertheless. We need accounting rules that acknowledge this.
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