New Mark-to-Market Rules for Money Funds
In May the Securities and Exchange Commission will start requiring that money funds hold more liquid and high-quality assets.
Under the new rules, a fund will now need to disclose monthly its actual “mark-to-market” net asset value, on a 60-day lag. This is known as a fund’s “shadow NAV.” Currently the shadow NAV is reported only twice a year.
Funds will also need to shorten the average maturities of their holdings. The maximum weighted average maturity of a fund’s portfolio is shortened to 60 days from 90 days. Funds will also have to maintain 10% of assets in securities that mature in one day and 30% in securities that mature in one week.
These new rules are in response to when the Reserve Primary Fund “broke the buck” in 2008 when share values dropped below $1 and touched off a withdrawal panic.
These new rules will make it harder to earn any income in a sorry market and in a low interest rate environment.
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US GAAP and IFRS Convergence Moving Along
International Accounting Standards Board Chairman Sir David Tweedie told the council of the European Union that the effort to reconcile Generally Accepted Accounting Principles (U.S. GAAP) and International Financial Reporting Standards (IFRS) is advancing.
“Both the FASB and the IASB have agreed upon common principles to help us to achieve a common standard,” he said. “That is our objective. At the same time, the IASB is conscious of the strongly held view of investors and other stake-holders internationally that a combination of cost-based and fair-value accounting remains appropriate for financial instruments.”
Earlier this year, the U.S. Securities and Exchange Commission reaffirmed its commitment to make a decision in 2011 to adopt converged standards by 2015 or 2016.
“For nearly 30 years, the Commission has promoted a single set of high-quality globally accepted accounting standards, which would advance the dual goals of improving financial reporting within the U.S. and reducing country-by-country disparities in financial reporting,” SEC Chairman Mary L. Schapiro said in a statement. “But supporting this goal is only the beginning of the discussion, not the end.”
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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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Marking A Loan Portfolio To Market Will Be Bad For Banking
Founder and Managing Director of Bradway Research LLC, Bill Bradway, when writing for Bank Systems & Technology, takes issue with the Financial Accounting Standards Board’s (FASB) efforts to expand banks’ use of mark-to-market accounting when valuing loans.
Aside from the risk of devaluation of the loans and the impact on capitalization, four questions Mr. Bradway raises are:
- What is the market value if the loan is current and has always been current?
- What loan underwriting variables need to be revalued? The borrower’s capacity to repay? The borrower’s latest credit score or rating? The value of the collateral underlying the loan? Two of the three? All three?
- Where do you start the mark-to-market process for a portfolio of loans?
- What technology applications are available to help value the loans? Compiling Excel spreadsheets would require an extraordinary commitment of time and resources.
Mr. Bradway then observes, “For all this effort, the mark to market portfolio of loans will not produce any more cash income as long as the borrower complies with the terms of the loan.”
This points out the problem with mark-to-market–isn’t a bond a loan? It is a loan, in a security form. Just because it has a cusip, does it deserve different or worse treatment?
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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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BOE — Suspending Mark to Market is “Moral Hazard”
Adam Posen, member of the Bank of England’s (BOE) monetary policy-setting committee, responded to a question from a Dallas audience, “If you have mark-to-market only suspended on the downside, you have the mother of moral hazard.” The question to which he was responding was whether the requirement for fair-value accounting exaggerated the recent financial crisis.
Mr. Posen was speaking at a conference on the euro. He also claimed that suspending mark to market was an invitation to “accounting games,” and that “The lesson from history is, avoiding mark to market tends to make things worse.”
Mr. Posen is an American and a former deputy director and senior fellow at the Peterson Institute for International Economics in Washington. He has also been an economist at the U.S. Federal Reserve Bank of New York and he has worked with the European Central Bank as well as the BOE. In 1999 he co-authored a book on inflation targeting with Federal Reserve Bank Chairman Ben Bernanke.
Posen’s right. If you have mark-to-market, it should go both ways. But it is aimed at the wrong target. Lack of capital and liquidity caused the run on the credit markets. Too much leverage. Let’s fix this first.
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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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