Silicon Economics Sues the FASB
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.”
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FDIC Exposes Mark-To-Market Gaps
When taking over a failed bank the Federal Deposit Insurance Corporation (FDIC) reveals vital information about the current market value of an institution’s assets.
There is a significant gap between the FDIC estimated values to those calculated by bank management using mark-to-model accounting subsequent to the Financial Accounting Standards Board (FASB) suspension of fair value accounting in April 2009,
Among recent bank failings the FDIC using mark-to-market accounting valued assets between 96-125% lower then bank management using mark-to-model accounting.
There are no reports of alleged fraud or negligence on the part of management in these bank failings.
Maybe this describes two things: 1) Bad/misbehaving management and/or 2) Liquidation value vs. economic value. Nothing to report here.
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IASB and FASB at Impasse over Mark-to-Market Accounting
Mark-to-market accounting is proving to be a major sticking point in efforts to converge the world’s two most important accounting systems, Generally Acceptable Accounting Principles (GAAP) and International Financial Reporting Standards (IASB). In September, the “Group of 20” leading industrialized nations pledged to create a single global set of accounting rules by June 2011.
In a joint statement, the International Accounting Standards Board (IASB) and the U.S. Financial Accounting Standards Board (FASB) said that they had failed to reach an agreement on the valuation of financial instruments. They commented that there was “no guarantee” they would be able to resolve their differences and that it “could affect the project timetables.”
The FASB supports a more widespread use of mark to market accounting than the IASB.
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One Year Later
It has been just over a year since the Financial Accounting Standards Board (FASB) suspended mark-to-market accounting. Since that time, when the Dow Jones Industrial Average was around 8,000, the market has gained about 35% in value.
No one is attributing the market rise solely to the change in accounting rules, but it can be argued that the change did have a positive influence on the overall state of the economy. Certainty over asset prices and the decreased volatility helped.
The banking sector, for example, was significantly impacted by the old mark-to-market rule. Since last year banks have been posting steadily improving profits. Citigroup recently announced a $4.4B for Q1 2010, their best in two years; JP Morgan Chase posted $3.3B for Q1 2010, up 55% from the prior year; and Bank of America exceeded analyst expectations with a $3.2B gain for Q1 2010.
Additionally it can be argued that the capitalization pressure on banks that was relieved by easing mark-to-market also made credit more readily available —credit that was necessary in every sector of the economy.
Bankers and Congress did pressure the FASB last year to change the rule. And although less onerous, the new mark to model version isn’t a license to mark things at any level the banks find convenient. There must be an economic rational for the marks, and the SEC can remind auditors that it is their job to make sure that is done prudently.
This all seems to be working. Let’s not change it now, or acquiesce to European rules. If it’s not broke…
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FASB and IASB Struggle to Meet in the Middle
While banks and politicians have leaned on accounting regulators to incorporate economic stability concerns into their accounting rules, the question of how banks should value financial instruments remains a subject of intense debate.
“Politicians have been saying a major objective of financial reporting is stability — we think it’s transparency,” said International Accounting Standards Board Chairman Sir David Tweedie.
The IASB had proposed to have assets valued at “amortized cost,” while the U.S. Financial Accounting Standards Board suggested that all financial instruments be valued at market levels. Valuing loans at a market rate would be a significant expansion of mark-to-market accounting, which has been vehemently opposed by the banks.
The FASB and IASB have been working over the last few months to reconcile their views.
Transparency is a better goal. Mark your bonds or loans to whatever price you think, then let the market decide whether you are a liar, a cheat or a charlatan. You just have to publicly disclose, quickly.
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New FASB Proposals Released
The FASB released two proposed accounting standards on Wednesday, 5/26/2010:
Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities—Financial Instruments (Topic 825) and Derivatives and Hedging (Topic 815)
Comprehensive Income (Topic 220): Statement of Comprehensive Income
The significance of the two proposals are that they would require virtually all financial instruments to be recorded at fair value on institution’s financial statements. This would be a radical change to existing financial reporting for lending and depository institutions and an unpopular one for the affected institutions. FASB recognizes this and the significant implementation issues and currently recommends an adoption date of more than 5 years for smaller institutions. The required adoption date for larger institutions is not yet determined.
Two of the five FASB Board members had some significant differences of opinion on the proposed standard.
The appropriate accounting for financial instruments has long been debated by the FASB and these current proposals are a part of a joint project the FASB originally started in 2005 with the IASB.
The two proposals can be found here:
Comprehensive Income (Topic 220): Statement of Comprehensive Income
Comment letters are due by September 30, 2010.
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First United Chairman Blasts FASB
In a recent letter to shareholders filed with the Security and Exchange Commission (SEC), First United Chairman and CEO William B. Grant addressed the company’s “first annual loss in memory” of $12.8 million. 2009 was the bank’s worst showing in 75 years.
Grant recognized expanded lending in hospitality, insurance and other sectors new to the bank’s portfolio as well as ill-advised real estate investments as the primary culprits. He noted that most of the losses came from “trust-preferred securities” in banks and insurance companies that defaulted on or deferred their obligations.
But he also blasted the “controversial accounting guidance” of the Financial Accounting Standings Board (FASB), taking special aim at mark-to-market accounting. He felt its requirement to recognize the hypothetical losses of potential assets provided an unfair “challenge” to First United and other institutions.
If everything was mark-to-market, you really couldn’t run the bank at anything else than a quarter-to-quarter basis. Short-term loans and short-term liabilities are the only way to ‘manage’ mark-to-market.
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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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FASB to Propose Banks Expand Use of Mark-to-Market
Bill Isaac, former FDIC Chairman, weighs in on the most recent discussions about FASB applying mark-to-market accounting to LOANS. “We should be frightened to death that the FASB might just do what it’s saying it’s going to do.”
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Update from FASB
Click on the link below for a summary update directly from the FASB on where they are at with regard to their changes on the subject of accounting for financial instruments . . .
FASB Technical Plan and Project Updates – FASB.org, March 10, 2010
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