FASB Unlikely to Suspend Mark to Market

The debate over mark to market (or model) accounting and its role in the financial crisis made its way to Congress yesterday (Thursday). The concern is that banks will not incur the losses booked per mark to market accounting as asset values recover over time from today’s clearance sale prices.

Last month the FASB initiated a project to improve guidance on determining fair value and on disclosure of fair value estimates. The project was scheduled for the second quarter and includes determining when a market is active or inactive and applying fair value to hedge fund and private equity investments. The project will now move forward sooner after House Panel gets FASB pledge on accounting rule.

A House panel wrung a pledge Thursday from the head of an accounting board to try to issue guidelines in three weeks that will ease rules that force banks to value assets at current prices.

The commitment by the chairman of the independent Financial Accounting Standards Board came amid a muscular display of congressional power at a hearing on the so-called mark-to-market accounting rules. The head of the House panel, Rep. Paul Kanjorski, D-Pa., had held out the threat of legislation to pressure the standard-setting board and the Securities and Exchange Commission to take steps that would give relief to battered banks.

Congressman Kanjorski’s threat of legislation should remain just a threat, as the free markets of the United States do not need politicians determining accounting standards.

"We may help save the jobs of several million Americans and help keep the country out of a worse economic situation" than the current one, Kanjorski said.

Moving accounting numbers around will not lead to consumer spending, job creation and growth. It will serve to give financial companies a breather and time to recapitalize.

I agree that to mark the value of all the houses on a street to the price of the one foreclosed home is inappropriate. On the way up these same companies (and their stocks) benefited from increasing asset values but now that the financial industry is at the edge of the cliff, these same rules look too strict.

The FASB Chairman did not put suspending mark to market accounting on the table. In fact, Chairman Herz had this to say in his testimony:

We agree with the SEC’s conclusion that fair value did not cause banks to fail. Rather, its use can help to more promptly reveal underlying problems at financial institutions. We also agree with the SEC that suspending or eliminating the existing fair value requirements would not be advisable, would diminish the quality and transparency of reporting, and could adversely affect investors’ confidence in the markets.

Of course, good accounting and reporting can have economic consequences, including potentially leading to what some term as procyclical behavior. Highlighting and exposing the deteriorating financial condition of a financial institution can result in investors deciding to sell their stock in the entity and lenders refusing to lend to it, to the company trying to shed problem assets, and to regulators and the capital markets recognizing that the institution may be in danger of failing and need additional capital.

I believe these (procyclical behavior) concerns are more effectively and appropriately addressed through regulatory mechanisms and via fiscal and monetary policy, than by trying to suppress or alter the financial information reported to investors and the capital markets.

The last thing the market needs is less transparency and more difficulty understanding financial institutions' balance sheets. The FASB, under tremendous pressure from Congress and Wall Street, will likely relax the rules by providing better guidance allowing companies to rely on their models more but require additional detailed disclosure. I hope Chairman Herz and the other FASB members find a good medium for fair value accounting that gives banks time to recapitalize and investors more detail about an institution’s holdings.

Disclosure: None

Comments

[Ranger:]

Either adjust M2M to a more realistic standard or let Congress disband the FASB, a group of crooks that make lawyers look like angels in comparison. I've been a Controller most of my life. I wouldn't let any member of the FASB in my office without preparations to fumigate the place afterwards.

Mar 14 12:08 PM

[henarl:]

The forced valuations resulting from M2M are no more "transparent" than values resulting from mark to cost. Neither reflects real value. If M2M is retained, then the loan to capitalization rules need to be changed.
Otherwise, we will not see the banks return to lending.
Whereas it would be nice to be able to go back to the days before fractional reserve banking and securitization, our present economy could not stand it.

Mar 14 12:23 PM

[Vanderpool:]

The present Mark to Market rules were put in place in the early '90s. This was done over the objections of banking experts such as the former FDIC chairman Bill Isaacs. (Isaacs as you know oversaw the government takeover of the Continental Illinois Bank).
The other time in our history when we had Mark to Market was... you guessed it... the Great Depression. Ultimately, Roosevelt was persuaded to rescind the onerous rules albeit 8 years later).
The idea of Mark to Market is to value assets to what is determined by the the market. Sounds good. But Isaacs and others who opposed this accounting rule asked "But what if there is no market?"
If there is no market then values will be non existent and we would soon find ourselves in a financial panic such as we have today, they argued.
Their fears have been borne out and now their advice is being heard in Washington. The new market values would be determined by cash flow. This is a better determinant of value in comparison to the absurdly low value assigned by the current market panic (read non-market).
The argument is that getting rid of Mark to Market will allow the banks to stop hoarding the Billions of taxpayer cash and instead put the money to work in the REAL economy.
You can't sail a boat without a rudder and you cant Mark to Market without a market. Replacing Mark to Market now will get things rolling again. There will be time to adjust the details later.

Mar 14 12:28 PM

[User 143167:]

The bank should not return to the lending as they did in the past. That is the CAUSE of the problem, not the solution. If you want to buy something, earn most of the money rather than borrow that money.
Debts are like opium, you feel better when you have more access to it, but it will finally destroy you as a whole.

On Mar 14 12:23 PM henarl wrote:

> The forced valuations resulting from M2M are no more "transparent"
> than values resulting from mark to cost. Neither reflects real value.
> If M2M is retained, then the loan to capitalization rules need to
> be changed.
> Otherwise, we will not see the banks return to lending.
> Whereas it would be nice to be able to go back to the days before
> fractional reserve banking and securitization, our present economy
> could not stand it.

Mar 14 12:49 PM

[tnmoneyman:]

>I agree that to mark the value of all the houses on a >street to the price of the one foreclosed home is >inappropriate.

What??? My comment isn't about mark to market in general but the article everyone thinks is so spot on. The author is trying to have it both ways. His comment on not lowering the value of houses on a street because of one foreclosure is disingenous to his thesis. Why wouldn't that foreclosure impact the other houses' valuations? How many foreclosures on the street would it take? What about houses that are valued for less than the raw materials in the house? If anything should be mark to market it is these houses. Not the financial instruments that he touts. These houses don't produce cash flows so the only way to value them is off the other similar houses' pricing, cost to build, and demand for the house. The financial instruments he feels should be mark to market do produce cash flows and should be valued based on holding to maturity and the other factors that effect their cash flow, not what someone would pay for it today in this insane environment.

Mar 14 03:34 PM

[Harry Tuttle:]

It is simply not true that Citibank's plight would be relieved by abolishing mark-to-market.

In fact, the banks already enjoy a lot of flexibility to value assets at "model" which means it is worth what someone AT THE BANK says. In addition, loans are also reserved at the discretion of the bank.

If you think this is too harsh consider the following. The total size of Citi's balance sheet is listed everywhere at 2 trillion. The astute analysts don't even bother to check the footnotes to "discover" that they have an additional trillion (with a "T") in off-balance sheet items.

People who are desperate for the Dow to go up can convince Geithner and Bernanke to buy S&P futures, but not even this will change reality. The losses are real and not a product of accounting.

Mar 14 04:38 PM

[vaughn:]

The issue is auditors. They don't like flexibility even if the FASB said loudly and clearly that market price is only one of the factors to be considered when evaluating the assets price in an inactive market.

The concept of mark to market is wrong. The mark to market is based on the assumption of liquidation, i.e., not a going concern. That means mark to market accounting assumes that an enterprise shall be valued on the liquidation basis, at a value that can be fetched now and right now, contrary to the nature of on-going business nature.

Under mark to market accounting, we have the ability to make all corporations insolvent. consider the following: If inventories are marked to market, then the last sale price in the internet will be used to mark down inventories, say, wallmart or target.As you are fully aware, the price on the internet sometimes can go extremely low.

How about a nuclear power plant? If a bankrupt utility was forced to auction off the nuclear power plant at 1/3 the value, that means all utilities having nuclear power plant must also mark down their nuclear power plant at 1/3 value which will immediately put all utilities in violation of loan covenant which will immediately put them into bankruptcy procedure.

Business must be valued on a continuing operating basis. Mark to market says business must be valued on the liquidation basis.

Mark to market is only useful in the monitoring of margin requirement, but is a weapon of mass destruction in measuring business operation.


On Mar 14 04:38 PM Harry Tuttle wrote:

> It is simply not true that Citibank's plight would be relieved by
> abolishing mark-to-market.
>
> In fact, the banks already enjoy a lot of flexibility to value assets
> at "model" which means it is worth what someone AT THE BANK says.
> In addition, loans are also reserved at the discretion of the bank.
>
>
> If you think this is too harsh consider the following. The total
> size of Citi's balance sheet is listed everywhere at 2 trillion.
> The astute analysts don't even bother to check the footnotes to "discover"
> that they have an additional trillion (with a "T") in off-balance
> sheet items.
>
> People who are desperate for the Dow to go up can convince Geithner
> and Bernanke to buy S&P futures, but not even this will change
> reality. The losses are real and not a product of accounting.

Mar 14 04:57 PM

[henarl:]

user 143167 wrote:

" If you want to buy something, earn most of the money rather than borrow that money."

I agree that is how things should have been. But they were not and now we are stuck with a broken economy that is, unfortunately, dependent on credit to exist. People are slowly starting to save again and only purchase what they can afford to buy with what they earn but meanwhile the economy is tanking, millions of people are losing their jobs, people are losing their homes to foreclosure, businesses are going bankrupt, and the Fed and the government are pouring huge amounts of money down a black hole. This is an emergency situation and requires actions that may be distasteful to the FASB but the alternative is likely to be the total collapse of the economy and several years of depression. The choice seems obvious.

Mar 14 05:05 PM

[Adult:]

All the above comment are writen by naive kid !

People supporting MTM base on one belief :

"Anyone who tell lie should be punished"

Let this 72 old man tell you the true :

"Human is dirty,we need to cover some of our dirty
parts in order for this world to function normally
(I mean normally not perfectly)".

All bankers are dirty & greedy.They caused this crisis
but if MTM wasn't be restored on 07,there should be
no crisis or more precisely -- no one know there is
a crisis as on the last 70 years after Franklin Roosevelt suspended MTM in 1938.


The real world is about "COMPROMISE".You just can't totally kill all bad guy in
order for this world to function.

Under MTM,it is just like asking all our congressman to
report if anyone have a mistress.If anyone have,then
they have to go.I can assure you that 60-70% of the
congressman have to go & the government will collapse.

FASB restored MTM due to Enron.But no accounting rule
can prevent people like Enron CEO to cheat,this kind of
people just write any number in their book.Accounting
rules can only control honest people.MTM has no use
on company like Enron but too strict on all others.

MTM fuel (not caused) the great depression in the 30
& Franklin Roosevelt suspended MTM in 1938.I hope Obama
has the same courage.

Supporter of MTM will be equal to asking all women to be naked ,100% transparency for man to find a honest
wife.I don't think it will work in real world.

Human is dirty,we need to cover some of our dirty
parts in order for this world to function normally
(I mean normally not perfectly).

Mar 14 07:45 PM

[sunny12945:]

Considering what Wall Street shenanigans have done on their balance sheet, in the past (Enron!), NO one will trust their Market to' Whatever they fantasize' value. This increases the opacity and reduces the confidence, when we need more transparency in the market place! There will be complete lOSS of confidence of our Financial Institutions!

Considering their balance sheet is full of MBSs, CDOs CDSs which are all declining rapidly as their VALUES (derivatives) are derived from Home mortgages (values), Auto loans CC loans etc. You don't have to be Sherlock to fore see the decline in the value of latter assets in the coming months! So will be, Banks' capital base with regard to liability.

GE declared only 2% of their balance as MTM rest - 98% is opaque. Look at it's stock price!

Supposing one (applying for Life Ins) diagnosed with cancer, you start blaming the doctor for divulging the truth and want to find one who will agree that you are not 'that bad' re your health!

There is a word for it, DENIAL! We now, are collectively and insanely in denial! You think things are worse now. Wait, after removing or even 'modifying' MTM according to wishes of holders of these toxic assets.

Who is going to trust their numbers?

Mar 14 08:12 PM

[dixie:]

Fair value accounting as promolgated by FASB and the FDIC is a misnomer.
There is nothing either intrinsically "fair" or representative of "value" about it. Both of these two groups are out of touch with reality and too often appear to have their respective heads where the sun doesn't shine.

A DCF model is both fair and realistic irrespective of the ups and downs of the economy.

Mar 14 08:13 PM

[nmelendez:]

The Real Truth:

All they had to do was switch the MBS from M2M to Mark to maturity and they would not have had any losses, This was all a short selling scheme to ripoff your retirement. Now in a depression their dollars will be worth much more and you will be in the doghouse. Congrats and remember if anything goes down more than 10% GET THE F#$% OUT!!!! Me, i made 4000 last year trading. Thank you for your contribution to my retirement!!!!

Mar 15 12:39 AM

[mrbill:]

“Short sellers can use mark to market in order to destroy otherwise solvent banks by manipulating the dysfunctional OTC market”

Sure. Blame it on the short sellers.

“By performing bogus transactions that drastically reduced CDO values way below fair market values under normal conditions, target bank(s) will be forced to mark even their prestine assets intended for 20 or 30 years hold to fire-sale prices as if they have already sold those assets at said fire-sale prices”

As long as the transactions are legal, sounds to me like you should take advantage of them. Why not buy today and wait for a market recovery? Is it because the market might not recover as you would expect?

There's no such thing as below fair market. The price for anything is what someone is willing to pay for it. Apparently, you and many others are trying to use the government to artificially prop up your investments. All on the taxpayers' dime.

Mar 15 07:23 AM

[mrbill:]

“All they had to do was switch the MBS from M2M to Mark to maturity and they would not have had any losses”

Right. The missing link: M2Maturity. Under this rule, there would have been no subprime fallout and alt-a/arm resets that are occurring today. Home prices would still be rising and consumers still spending. Oil would be at $300 a barrel, tomatoes at $12 a pound and we'd live happily ever after.

Mar 15 07:25 AM

[mrktcap:]

I really hope this market rally holds, who really wants another major market landslide when buying into this rally. It was told in November, we hit bottom. Buy Buy Buy. and look what happened. I personally don't want to give up my summer vacation for false profits like I did for Christmas.
Be deer in this market. Stay clear of the bears and bulls that false pump the market for their greedy gain. Don't forget China might be pulling back its buying of gov't bonds, so don't tell me there isn't political tension to make the market rally.

Mar 15 09:08 AM

[gtmcduffy@g...:]

Well said...finally- a comment from someone that has nailed it to a "T" (and a dotted i)


On Mar 13 01:39 PM Bill Herbert wrote:

> As a CPA, I am 100% in favor of modifying Mark to Market Accounting
> for circumstances such as we are now in. To pretend that we have
> anything resembling a normal market is utterly laughable, and therefore
> it is ludicrous to mandate that a bank must take a very low mark
> on an asset pool that, as one poster says, has a much higher PV based
> on cash flows, given all known defects and reasonable expectations.
>
>
> The SEC has been an abomination for years, and I frankly don't think
> much of FASB either. The SEC has completely dropped the ball in its
> most important function, which is of course to police markets and
> try to eliminate front-running, market manipulation, fraud and so
> on. They have done an absolutely terrible job at that task for at
> least ten years, and worst by far under the term of Cox and several
> of the disgraceful Republican 'free-market' commissioners of the
> past few years.
>
> So what did they do? They decided to implement FASB 157 in a strict
> sense without having any guidelines as to market effects or illiquid
> markets. Thereby, they created an enormous self-feeding financial
> panic that has so far led to grievous harm and tremendous economic
> loss.
>
> I cannot blame them entirely for the conditions that led up to the
> panic - grossly off-the-charts fraud and corruption on Wall Street
> and the mortgage markets. Part of the bad behavior was due to sheer
> greed and flawed models, and even a very effective regulator would
> have stopped a good bit, but not all.
>
> I liken it to striking a match after allowing a bunch of vandals
> to pile up tinder and douse it with kerosene. The SEC in its perverse
> way did great harm to a market that they were supposedly trying to
> help function effectively.
>
> FASB on the other hand has a long history of issuing very long, complicated
> and sometimes tortuously contradictory "statements" that make accounting
> cumbersome, way too open to different interpretations, and often
> very easy to manipulate. The FASB really needs a complete overhaul
> - I would suggest that they get rid of most of the academics and
> theorists, many of whom have never done much more than issue a bunch
> of white papers at universities - and put a panel together consisting
> of industry controllers and CFOs, as well as a few executive types,
> like for instance Larry Bossidy.
>
> I would also include several ombudsman-type people from the real
> world, who might best be described as "investor representatives"
> who would ensure a common thread of transparency and accurate reporting
> that is useful, relevant, and very accessible to the average investor.
>
>
> They would certainly benefit somewhat from suggestions from Wall
> Street, but that should be limited to a comment period. Nobody who
> is a banker or has a large financial interest in a company should
> be allowed to help write the accounting rules, especially not brokerage
> execs.
>
> Mark to Market should be modified to ensure that there is an active,
> functioning market, to be used as a reference - when there is none,
> it simply doesn't apply.
>
> Off Balance Sheet entities are a complete joke, always have been,
> and should be immediately scrapped.
>
> The whole idea should be to simplify instead of compound the problems
> and complexity, which is what FASB seems very good at doing.
>
> It should also greatly simplify and streamline the Sarbanes-Oxley
> documentation process, establishing a clear standard and usable templates,
> so that the "Big 4" accounting firms can stop ripping off their clients
> by forcing them to jump through 100 useless and totally insane hoops,
> all while the accountant's meter is running.
>
> No wonder people hate accountants - they did it to themselves through
> the utter stupidity and self-enriching nature of the system they
> constructed for the business world.

Mar 15 09:17 AM

[canadian_in...:]

The real problem with mark-to-market is not the VALUE of the POTENTIAL losses, it’s their AMORTIZATION.

For MANY kinds of LONG-TERM assets, accounting rules managed to come up with different AMORTIZATION techniques (trying to show the REAL losses of value over the EXPECTED LIFE of the ASSET by applying different durations and linearity). Why is it different with MBS or CDOs?

The PURPOSE of accounting is to REFLECT THE REALITY OF THE UNDERLYING BUSINESS. Even if these MARKETS are EFFICIENT and they REFLECT THE REAL VALUE of these assets, requiring write downs (thus UPFRONT capital TODAY) for your next 3, 5 or in some cases 20 years of MARKET ESTIMATED LOSSES will look very stupid 70 years from now… just like it probably did in 1938!

Mar 15 11:02 AM

[j_remington:]

The value of a foreclosed house may still be overvalued. Home prices in some neighborhoods have not bottomed. What about MBS involved in those neighborhoods?

Arguments to change mark-to-market are full of holes.

Mar 15 08:01 PM

[William Cowie:]

If MTM is eliminated, now is not the time. At the moment, the pain is merely the correction of the inflation baked into banks' statements. So, one way or another, that has to be flushed out. It hurts, it's painful to watch, but it's necessary. And if the irresponsible fail, so be it. But we cannot stop the treatment because the medicine tastes bad. We have to flush the bad loans out first.

But, once we emerge from the carnage, it may be helpful to

(a) move MTM to a required note, but get it off the statements. Transparency is served if (like the MD&A) MTM is a required disclosure. It can even be required as a separate detailed disclosure, like the Owners Equity section in the 10-K financials.

(b) by implication, remove increasing MTM values from a financial institution's lending ability. It's true, they may circumvent this by trading, but at least this removes the automatic expansion of credit caused by a bubble or inflation. Thus, it (to some small degree) creates a natural impediment to bubbles forming.

(c) limit it to assets that are marketable in the foreseeable future. In other words, for banks, the value of loans will be left alone.

(d) of course, prudent markdowns must still be required, as they are at present for all classes of assets, goodwill in particular.

The bottom line: now is not the time to eliminate MTM. If we do it, we have to wait till the toilet is completely flushed, else we'll sow the seeds for the next bubble right there.

Mar 15 10:46 PM

[MattZN:]

I think both the author and respondents are missing the point. This has to do with mortgages the bank intends to hold for itself. The fair value of this mortgage portfolio should be discounted based on a combination of the expected default rate and the relative value of the asset were it to default. Only half of that equation is mark-to-market.

The default rate has nothing whatsoever to do with the market value of the assets. Mark-to-market alone is not appropriate for these assets, and neither is recording them at their full value on the books. Something in-between which better approximates the inclusion of the default rate on the portfolio would be far less volatile in an illiquid market and much more appropriate.

Mortgages held for sale would have to operate on a different set of rules, ones which would be aligned closer to mark-to-market. They are two different beasts.

-Matt

Mar 16 12:59 AM