Investment Banks, Rumors, the Trough, and Fair Value Accounting 11 comments
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From Bloomberg: Former Bear Stearns CEO Greenberg Says Investment Banks ‘Gone’ .
“There’s no more Wall Street,” Greenberg, 81, said in an interview to be aired on Bloomberg’s “Money & Politics” television program. “That model just doesn’t work because it’s at the mercy of rumors.” Really??!! Would these be the rumors that you bought a bunch of bad assets with a lot of leverage at the top of a bursting bubble?
Greenberg elected to stay when JPMorgan Chase & Co. (JPM) acquired Bear Stearns through a forced sale in March. The acquisition followed a run by clients and lenders that left Bear Stearns on the brink of bankruptcy. Market rumors helped cause customers to pull their money from Bear Stearns and Lehman Brothers Holdings Inc., (LEHMQ.PK) and pushed down the stock prices, he said. I would think your balance sheet and opaque reporting helped to cause customers to pull their money from Bear Stearns and Lehman Brothers. See Is this the Breaking of the Bear? and Bear Fight - A most bearish view on Bear Stearns in a bear market.
The entire make-up of Wall Street has changed “forever,” Greenberg said. This year has seen the demise of Bear Stearns and Lehman, Bank of America Corp.’s (BAC) purchase of Merrill Lynch & Co. (MER) and the conversion of Morgan Stanley and Goldman Sachs Group Inc. into bank holding companies.
“Rumors can start and turn into a self-fulfilling prophesy,” Greenberg said during an interview in Washington. He said he’s “never seen anything close” to the current economic decline and turmoil in the financial markets. Excessive leverage and economically imprudent asset purchases can turn massive profit into the truth, as well.
Financial firms worldwide have taken $980 billion in writedowns, losses and credit provisions since the start of the crisis. More than 201,000 employees have lost their jobs. Is this all due to rumors?!
And on the flip side…
Behind Schwarzman Spat With Wasserstein Over Fair Value Lies FASB Rule 115
An argument between two Wall Street titans seated in director’s chairs at Per Se restaurant in New York in October has escalated into a fight over an obscure accounting rule known as Statement No. 115. Five weeks ago the dispute was over so-called fair-value accounting, which requires companies to record assets every quarter to reflect market value. In one chair was Blackstone Group LP (BX) Chairman Stephen Schwarzman, who said the standard had aggravated the worst financial crisis since the Great Depression (the fiction, how dare investors find the gall to ask us what our assets are really worth in the open market???). In the other was Lazard Ltd. Chairman Bruce Wasserstein, who said the rule gives investors an honest look at corporate earnings (the facts: The Truth! The Truth! You can’t handle the TRUTH! – channeling Jack Nicholson in “A Few Good Men”).
Now banks, which have been unsuccessful in getting regulators to revamp fair-value, also known as mark-to-market, are trying to win revisions to another U.S. Financial Accounting Standards Board requirement that could preserve billions of dollars of their capital. Hey, if at first you don’t succeed, lobby, lobby again…
“Financial institutions, which have been woefully incompetent in running their own firms, are now trying to avoid providing investors with accurate numbers depicting the large losses they have suffered under their mismanagement,” said Lynn Turner, the Securities and Exchange Commission’s former chief accountant, in an interview.
… In a Nov. 12 letter to the SEC, Robert Traficanti, Citigroup’s (C) head of accounting policy, gave an example of mortgage-backed securities the bank owns and said the rule change would reduce a third-quarter charge to earnings to $19.2 million from $76.2 million. The proposed switch “is a much better reflection of the losses we expect to incur,” he wrote. I think the problem with this statement is that the losses that you expected to incur really did not coincide with the losses that you actually incurred. That is really the crux of the entire asset securitization crisis, now isn’t it?
By using standard 115, banks could take into account cash generated from underlying assets such as mortgages and not rely on a market price dictated by the fair-value rule. If I am not mistaken, if the cash generated by the assets were so sufficient, and the market undervalues these assets so greatly, then what we have on our hands are the best yielding deals of the century. That being the case, all of us (or those, since I am not really all that bright) smart guys with those high falutin’ C++ fortified, Mathematica mutated Excel spreadsheets should be knockin’ ya door down to get these assets off of your books for you.
Hmmmm… I wonder why nobody is biting. Well, I guess it doesn’t matter that nobody wants them. It doesn’t matter that earlier this year banks were willing to finance the sale of these assets at cut rate interest to get them off of their books at discounts steeper than 50%. It doesn’t matter that the only ones willing to buy them now are the same guys still looking for WMDs in Iraq. You just want us to ignore what their transfer price is, and allow you to project future cash flows as a valuation. I do believe we have had enough of projections, which is why investors want to rely on market pricing. Hey, you can always take extant cash flows and inure them to the income statement, right? Just don’t start that projection, in perpetuity stuff.
Moving to the impaired debt and equity standard would help “stop the downward spiral caused by the inability of ivory tower accounting rules to recognize the economic value of an asset,” Scott Talbott, the Washington-based roundtable’s chief lobbyist, said in an interview.
Now, this is interesting. If the economic value of the asset is not matching the market value of the asset, as I stated earlier, why isn’t everyone who knows how to count buying this stuff up? Particularly private equity, who need not be bothered by the whims of the public equity markets. I think I know the answer.
… The rule “and the way it’s been implemented has been a major contributor to the financial crisis,” Schwarzman said at the Oct. 30 discussion hosted by Fortune magazine at Per Se. Or… Leverage, valuation, risk assessment, and the way they have been implemented have been the major contributors to the financial crisis.
Wasserstein, 60, who has a better track record this year with Lazard declining 37 percent in NYSE composite trading, took the opposite position. “Accounting has now become an exercise in creative fiction,” he said. “Saying assets are worth a lot doesn’t make them worth a lot.” … Ya’ think??? Hey, don’t say that in public. I want to say my assets are worth a lot…
Two of Obama’s closest economic advisers, former Treasury Secretary Lawrence Summers and former Federal Reserve Chairman Paul Volcker, have expressed support for fair-value accounting. So have Fed Chairman Ben S. Bernanke and Treasury Secretary Henry Paulson, who said on Nov. 20 that he knows of “no better accounting method,” even as he welcomed “steps to review and modify its implementation during severe market stress.” Uh, oh. The market may be turning. I actually agree with Paulson on something.
Private-equity executives, including Schwarzman, say mark- to-market accounting unfairly forces them to value holdings even if they have no intention of selling them at that time, hindering the business model of fixing up companies and disposing of them years later for a profit. WHAAAT????!!!! What the hell does that mean? How does it hinder the business model? You acquire assets, you work on them until you can sell them for more, then you do so. The fact that until you can sell them for more, they are not worth more makes perfect sense – doesn’t it?
Do these guys actually expect us to believe that we should allow them to value these assets for more despite the fact that their own business model dictates that they are not worth more? After all, the entire premise behind private equity is buy low and sell high. They want us to change this to buy low, value high, and then sell high when the market value really is high. Wheww!!! You need to be high just to wrap your head around that one. You guys must be smoking some of that high grade cannabis that only private equity guys can afford.
Brian Wesbury, chief economist at First Trust Advisors LP in Lisle, Illinois, compared the idea of forcing banks to price their assets now to a homeowner in California having to sell his house at the moment a fire is at his doorstep. “If the bank knocked on your door and forced you to mark to market at that moment, you’d be bankrupt,” Wesbury said. What a silly statement. Whether you are forced to mark at the moment or not, your house is worth what it is worth. Do you mean to tell me that the guy whose house is burning down should now be allowed to say his house is worth a million dollars even though it is burned to the ground? He gets that million dollar valuation why? Because if he doesn’t he will be broke? Since when does a company’s financial dependency on an asset’s valuation affect that asset’s valuation? Oh yeah, that’s the way it has always been, it’s just that light is being shined on it now.
Citigroup Senior Vice Chairman William Rhodes and Deutsche Bank AG Chief Executive Officer Josef Ackermann are also fair- value critics. The two men, speaking in October in Washington on behalf of the Institute of International Finance, a global association of financial institutions, said the rule needs a review because it doesn’t work in illiquid markets. It works just fine in illiquid markets. If you can’t sell it for X price, it is not worth X. That is why there is a discount given to an asset for a lack of liquidity. That is why public company shares are given a premium over private companies’ shares, because they are easier to sell. Think long and hard about this. If we allow banks to totally disregard the liquidity premium, do we mark down all publicly traded securities in kind, or do we model / mark up all private securities. When does this nonsense cease?
… Fair-value’s fans portray the complaints as sour grapes by banks that don’t want to admit how bad their subprime investments were. Sour grapes, bad weed, whatever. Blaming the rule for the credit crisis “is a lot like going to a doctor for a diagnosis and then blaming him for telling you that you are sick,” JPMorgan Chase & Co. analyst Dane Mott wrote in a September report. What do you mean? I’m not sick, because my model tells me I’m healthy - Cough, Cough!!!
Matthew Schroeder, managing director for accounting policy at Goldman Sachs Group Inc., is another fair-value advocate. “For us, fair value is the oxygen of the firm,” he told the SEC in July. “It’s part of our fabric. We follow a daily discipline of marking to market at our firm. It can be done.”
This all boils down to the fact that big banks believe that even in this day and age of instant information transmittal and topic experts blogging on every conceivable issue without big brother watching over them (yet), they can still (and worse yet, believe they have the right to) purposely pull the wool over investors eyes by outright declaring that market values should not be reflected in their holdings. The next time a bank tries to buy something from me, I should play the same game. “You will have to pay me a lot more for this sir. Although everybody else is paying $100,000, my models say the market is not valuing my stuff correctly and I want $250,000 for it. After all, it threw off $1,000 of cash last month and it has a maturity of 360 months. That means I should get the present value of $360,000, which is about a cool quarter million.
What?! What did you say? You dare compare my prime, Moody’s and S&P AAA rated assets to that junk that guy over there has?!!! My underwriting insisted on high FICO scores and special “expedited appraisals performed by the bank’s specially trained inhouse staff and custom written software. We own debt collateralized by the best areas of Vegas, LA and Miami. Prime shit, do you understand!!!??? We don’t adhere to the market here. Just because those guys' assets defaulted doesn’t mean ours will. Those collateral values will shoot right back up to the 30% per year appreciation rate that was used to underwrite the securities in no time. Now hurry up and buy mortgage bonds before rates reset and these guys default on their 3rd forbearance agreement!”
Disclosure: None
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On Dec 10 07:18 AM User 316598 wrote:
> "Mark to Market" has been unnecessarily devestating. Your sarcastic
> tone makes it clear that you support the concept, but it has distorted
> "true" values by creating a devaluing atmosphere of fear. There is
> currently no sane market for the securities. One reason the "market"
> for mortgage securities has collapsed is that any purchaser fears
> that they may have to "mark" the value due to fear rather than intrinsic
> value. There is no good distinction inthe market between a "good"
> performing mortgage related security and a bad one. This drives the
> "market" price lower, which in turn ratifies the fear. The negative
> feedback loop is devestating to financial firms holding these securities.
Mark-to-Market rules were passed by Congress in 1993 to resolve a Bank One IRS case. Somehow, for the prior few hundred years, cost-accounting rules applied quite well.
A few years ago, my company transferred me and agreed to buy my house. When they came in with an offer, I was astounded to find it was significantly less than comparable houses in the neighborhood. I found out why. The company asked the appraisers to apply a "quick sale" method. That's where they appraise the property based on a sale within 30 days. Now very few homes sell within 30 days, right? So to reflect the 30 day rule, appraisers discount comparables by 20%-40%.
So here's the question: What's the value of your home? No, not with a fire on the doorstep, but with a time constraint to sell. What's the value if you must sell in a 24 hour period, a 30 day period or a 180 day period? And since there are different values based on those different time horizons, why is it mandatory to value it on the shorter of those time periods?
And for banks, where the balance sheet dictates the amount of loans they can provide or even their basic government mandated solvency, for someone other than the bank itself to declare what the time horizon can - and in today's environment, is catastrophic.
So to treat mark-to-market rules as some Holy Grail makes no sense whatsoever.
I don't know which rule makes sense and valuing cash flows could also make sense it seems. What doesn't make sense is to change the rules when circumstances change. I bet you the same one will cry to go back to MtM when markets are up because Cash Flow accounting or else doesn't correctly reflects the rarity effect or whatever else.
Market prices can be maniplated. Can the foundation of the economy and the accounting profession rest on the value of something that can be manipulated?
Can a person believe that the current 3 month T Bill yield is a fair market value? It's only a snapshot of value for liquidity purposes but a long-term fair value.
Confusing a fair value and a liquidity value is a mistake.
Behind Schwarzman Spat With Wasserstein Over Fair Value Lies FASB Rule 115
An argument between two Wall Street titans seated in director’s chairs at Per Se restaurant in New York in October has escalated into a fight over an obscure accounting rule known as Statement No. 115. Five weeks ago the dispute was over so-called fair-value accounting, which requires companies to record assets every quarter to reflect market value. In one chair was Blackstone Group LP (BX) Chairman Stephen Schwarzman, who said the standard had aggravated the worst financial crisis since the Great Depression (the fiction, how dare investors find the gall to ask us what our assets are really worth in the open market???). In the other was Lazard Ltd. Chairman Bruce Wasserstein, who said the rule gives investors an honest look at corporate earnings (the facts: The Truth! The Truth! You can’t handle the TRUTH! – channeling Jack Nicholson in “A Few Good Men”).
Now banks, which have been unsuccessful in getting regulators to revamp fair-value, also known as mark-to-market, are trying to win revisions to another U.S. Financial Accounting Standards Board requirement that could preserve billions of dollars of their capital. Hey, if at first you don’t succeed, lobby, lobby again…
“Financial institutions, which have been woefully incompetent in running their own firms, are now trying to avoid providing investors with accurate numbers depicting the large losses they have suffered under their mismanagement,” said Lynn Turner, the Securities and Exchange
"The mark- to- market accounting almost destroyed the financial system in late September when the broad bond market dropped over 15%.
Market prices can be maniplated. Can the foundation of the economy and the accounting profession rest on the value of something that can be manipulated? "
Which is easier to manipulate, a centi-billion dollar or multi-trillion dollar market, or a proprietary spreadsheet model on some analyst's or trader's hard drive who just so happens to derive a salary and bonus from the company holding the asset?
Which would you rely upon to be least likely to be manipulated out of those two choices?