New Accounting Practices Will Boost Bank Equity Values

In case you missed it, the SEC has announced new accounting rules that will help companies value illiquid assets.

Taken from this article, Rethink of rules on value boosts banks

The Securities and Exchange Commission said on Tuesday that managers could use their own judgment when valuing securities in illiquid markets, which means they can use measurements other than actual market prices.

I believe this is utter hogwash. Bank managers should never be allowed to use a measurement other than Mark to Market to value an illiquid asset. This kind of accounting applied to a typical wholesaler would create a huge mis-valued inventory. Lets say I owned a company that sold sportswear. If there were suddenly no market for my particular brand of sportswear, the new accounting rules would allow me to book a subjective value for the inventory assets instead of basing them on true closeout prices.

The new rules will benefit most of the large banks such as JP Morgan (JPM) and Goldman Sachs (GS). I’m not sure if the SEC’s decision is wise, since it will just mask the problem of investor confidence and an on-the-brink failure of the OTC derivatives market. I believe the new rules will also give leeway to possible accounting manipulation. For investors, the rules further obscure our ability to determine the value of a company's equity.

Mark to Market is an important principal behind our financial ecosystem. To read more about Mark to Market, I suggest this article, Financial Crisis: Mark to Market Accounting Demystified.

Taken from the article:

[Mark to Market]…was primarily intended to prevent shady accounting practices that hide underlying liabilities. The Accounting Standards bodies were concerned that companies were keeping “bad” assets on their books instead of “writing them down” to their real value (assigning a new, lower value to the asset). Mark to Market gives investors a much better “picture” of the health of the company if their assets are correctly priced (i.e. market price).

Comments

[Andy Singh:]

Thanks for the mention of my article. Glad the SEC is acting and I will check out the other article you mentioned here.

2008 Oct 29 09:26 AM

[ebreen:]

The critical problem with mark to market theory is how it interacts with Sarbanes-Oxley and the present state of securities law. This issue is usually left out of the discussion as it has been here in your post. Mark to Market has always contained an alternate method of valuation when there is no functioning market provided the rational for the alternate value is fully disclosed in footnotes. However, in practice where SarBox has criminalized accounting practice that turns out to be overly optimistic and where the securities bar targets all grey area decisions, there is no reward for any CFO or Accountant Firm to apply any leway where there is some market value information, no matter how distorted that infrormation my be. There is simply too much risk..including the risk of personal freedom and liability...to apply an alternate risk adjusted mark to maturity value where there has been any reported market sale no matter the duress of that market sale. So, the real problem is SarBox defeats the flexibility of FSB 157 and causes a mark to non-market lowest value. SarBox is the law that needs the reform.

2008 Oct 29 09:40 AM

[tk77mann:]

While Mark to Market can be painful, think of how painful other more judgemental valuation methods are in the hands of bad and / or corrupt management. Enron managers would have loved to be able to set their own (wildly inflated) values on crooked assets. They might have avoided going to jail for even longer than they did.

The bottom line is companies have to minimize illiquid assets whose values are not easily judged.

2008 Oct 29 12:17 PM

[wsd:]

your home mortgage is one of a kind. For all practical purposes it is an illiquid security with no market. Since no market exists is your mortgage is zero? I doubt it. Market to market for non trading securites where there is no market is an moronic approach of no value.

2008 Oct 29 02:10 PM

[PainfullyAware:]

This system gets more Wack By The Day.

When the rules get in the way - change the rules. Obviously the rules appear to be a bunch of junk.

Good point ebreen on the interaction of regulation. That is what you get when you have people who do not look at the system as a whole and also do not consider both best and worst case scenarios before they mandate laws.

Chimps could have probably come up with something just as good.

The Circus Continues - Down With Clowns !!!

2008 Oct 30 07:37 PM