Accounting Rule Changes Creating False Rally in Financials 33 comments
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On Friday, a veteran Wall Street analyst predicted that, despite recent gains, bank shares now incorporated significant further upside. “Within weeks, we will see major changes to mark-to-market and fair-value rules,” she told CNBC. “The changes will enable the banks to rationalize solvency ratios in the current climate, to get on with their business and to post higher operating profits.”
Her comments followed a day after the House Financial Services subcommittee warned the Financial Accounting Standards Board (FASB) and the SEC in no uncertain terms to alter the manner in which assets are valued within weeks or face legislative action on the issue. (The SEC interprets and enforces FASB standards). Congressmen apart, numerous key participants in the capital markets, including publisher Steve Forbes, are convinced that the mark-to-market rule itself was the principle reason for the financial meltdown. Edward Yingling, president of the American Bankers Association, says that House subcommittee’s proposition addresses “systemic risks that accounting standards can have on the economy.”
But accounting methodologies don’t create systemic risks; systemic risks are generated when leverage and counterparty risks collide, particularly in circumstances where key economic indicators (like joblessness, household net worth and consumer demand) turn decisively negative. Mr. Yingling is not alone in attempting to give Americans the impression that the banking crisis is not a consequence of irresponsible lending, poor risk management practices and derivatives-induced leverage. Wall Street’s bankers have also started to publicly claim that the “maturity value” of the assets on their books is much higher than valuations implied either from marking those assets to the market or from unduly conservative measurements of illiquid holdings (Level 3, FAS 157).
The first problem is that when asset values, including home prices, were breaking one record after another, the same bankers were quite happy to work with the mark-to-market rule; in fact, the rule enabled Wall Street’s financial institutions to expand leverage, to declare impressive profits and to structure credit default swaps and collateral debt obligations by relying on counterparty risk guidelines established by the rating agencies.
The second, and more serious problem, is that the largest components of systemic risk today are rooted in status of counterparty credit, domestically and internationally, with respect to trillions of dollars of currency swaps, structured notes, index puts and far-forward foreign exchange contracts; this exposure is outside the CDS and CDO matrix. Financial policy makers within the Obama Administration appear to have decided to defer the true assessment, and public disclosure, of such systemic risk by essentially manipulating accounting standards. Two weeks ago, the focus was on “stress tests”. Now, for good reason, there is silence on that front.
Because any credible stress test must incorporate two fundamentals: inputs on the future shape of the underlying economy and variations in counterparty risk. A Citigroup (C) risk manager told this writer yesterday that, “in broad terms, counterparty risk will improve with an economic turnaround, that's what we are assuming.” That may or may not be the case.
Information from Eastern Europe, for example, suggests that by the time any economic turnaround becomes a reality, hundreds of counterparties will simply walk away from derivative contracts and structured products. A number of corporations in India have stopped complying with margin calls for swaps and forwards. The biggest shock waves in the counterparty risk area are due from the impending collapse of the Eurozone. Noticeably, Citigroup CEO Vikram Pandit, in his email letter to Citi employees on March 9, 2009, did not reveal if counterparty risk was included in stress tests his bank conducted.
Bulls and value investors on Wall Street have been busy this weekend selling the notion that the forthcoming changes in accounting rules, and the fiscal and monetary solutions to be agreed upon at a G-20 Summit in the first week of April, make a solid case for aggressive purchases of Bank of America (BAC), Citigroup, JPMorgan Chase (JPM), Morgan Stanley (MS) and Wells Fargo (WFC). One hedge fund manager is looking at an 80-100% rise in BofA and Citi, and 30-50% gains in JP Morgan, Morgan Stanley and Wells Fargo, by the end of this month.
Without doubt, since fully-informed investors form only a small proportion of the capital markets, the spin and hype surrounding the “inherent evils” of the mark-to-market rule and Level 3 measurements could well take bank shares significantly higher this week. If that happens, this writer will re-initiate shorts. The determination of influential Congressmen to legislate yet another bubble is frightening indeed; changes in accounting rules will reinstate (and substantively increase) the very systemic risks which Ben Bernanke has been seeking to eliminate, or postpone, since the tumultuous days of the Bear Stearns rescue.
Disclosure: Author holds short positions in GE, XLF
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This article has 33 comments:
Change the rules when they are no longer a benefit to the banks. To funny
If my stocks,options,futures... marked to market daily,
why should the Banks not be subject to the same rules.
The idea that holding those assets till maturity would
make them worth more is preposterous.Did those guys hear
about the concept of present value?
I cringe to see Senator Dodd,and Rep Frank,make financial statements,as I do Cramer on mad Money,who by the way just discovered technical analysis.
It is farcical.
First, only assets (and liabilities) designated by the bank itself as TRADING assets are subject to mark-to-market and the gain or losses impact earnings and consequently regulatory capital. Let's dwell on this for a moment the banks acquired the assets and they decided they wanted to use mark-to-market accounting because they INTENDED to trade the assets! no one 'forced' them to do so.
Second, when there no longer is a functioning market for a trading assets the banks can use Level 2 or Level 3 methods to value the assets (Level 1 is to use availble quotes). Level 3 can be best described as mark-to-model -it has nothing to do with any quotes. The bank forecasts cashflows and durations then values these cashlows using discount rates they believe appropriate.
So assets that were once so liquid that the banks bought them to trade (ie never had the intention to hold to maturity) and now turns out that there is a wide gap between what the owner and the potential buyer thinks they are worth are now valued by the banks at values they think they are worth and not at the bid price.
Assets the banks designated as available for sale are subject to the same mark-to-market rules as the trading asstes but the resultant gain or losses do not effect income (they are booked directly net of taxes to equity through accumulated other comprehensive income or AOCI) nor dor they have any impact on regulator capital.
Third, the overwhelming majority of the banks assets (and more importantly the banks credit exposure and source of future losses) are valued at amortized historical cost.
Mark-to-market has neither forced banks to sell assets at prices they consider too low nor has it forced them to raise capital or sell other liquid assets to meet capital demands.
On Mar 15 03:01 AM ccerenz2 wrote:
> This author clearly doesn't understand the negative downward pressure
> that Mark to market has on assets in a declining market.
Anyway, what about what happens when demand for housing comes back. Which is likely much sooner than people think. Housing starts will start a multi-year pick-up, likely starting in late 2009, 2010 at the latest.
news.morningstar.com/a...
Look especially at the graph of actual housing starts to presumed long term demand on page 2. We actually had a larger new starts boom years ago, and the dip has already been more severe and almost as long. We have overshot to the downside. Eventually demographics will win out. And eventually, the supposedly reinforcing downward slide of earnings, joblessness and gdp does stop. It always has. Pricing may change, and how financed, but demand will return in spades, and some toxic assets will bounce back.
After a pullback from this run, I'd rather long xlf than short it, but I'd also consider some homebuilders, plum creek timber, etc.
The net result of which may be a temporary fix.
The pundits come out and convince the public that the banks are a buy and safe investment,banks share prices rise.....onward and upward until the powers that be fleece the public all over again.The big, trapped investors(Arabs or Chinese) in Citi or another failed bank get to sell at better prices,and low and behold the bond holders are saved!!!!!!reminds me of Enron or World Com only this time its brought to you by Congress..btw I secretly feel they would rather tax you more and just continually hand over the money,but this way is so much more democratic.Don't you think?
On Mar 15 04:07 AM jeandit75 wrote:
> Keep shorting XLF my friend, I'll buy your supply of sotcks. You
> have to understand that a temporary end to the M2M will stop the
> bleeding of banks. It means they can stop marking assets down and
> don't need capital injections anymore. It will stabilize the system
> for awhile. It will help them breathe and move to start doing business
> again. The real economy needs the banks to function well. Theses
> shares are currently climbing a wall of worry. What is interesting
> for me is people like you are still not believers. Once you start
> to understand the benefits of the change of those crazy accounting
> rules, people like me will have made a ton of money buying banks.
> Now, this does not mean that it is the end of the problems for banks.
> The credit outlook remains gloomy. But at least, banks will now have
> some flexibility to adjust to the environment instead of having to
> beg for capital from the government. For that simple reason, bank
> and insurance shares are due for a massive bear market rally.
Simply call the "toxic" assets "non toxic". Now, who will buy at "face value" when they wouldn't buy at M2M value? Oh, I forgot, financial institutions are not selling now, they are waiting till maturity. Since the money supply will be inflated by then there should be no problem. Right?
Hopefully, this isn't a ruse to get the government to buy this stuff at notional value.
On Mar 15 06:46 AM GSaad wrote:
> The congress again is attempting to choose the easy solution,doing
> away with mark to market.
> If my stocks,options,futures... marked to market daily,
> why should the Banks not be subject to the same rules.
> The idea that holding those assets till maturity would
> make them worth more is preposterous.Did those guys hear
> about the concept of present value?
> I cringe to see Senator Dodd,and Rep Frank,make financial statements,as
> I do Cramer on mad Money,who by the way just discovered technical
> analysis.
> It is farcical.
>
Really, so AIG and CITI are making voluntary choices when they sell their remaining profitable businesses, and the Bond rating analysts don't care if the quarter was profitable because the write downs just nuked their bottom lines and the bond rating is coming down anyway. Get your head out of. M2M is like "gun to the head" accounting principles. Today you are underwater on your, (house, car, rent properties, etc.) pay up or sell into an illiquid market. A seller that doesn't want to sell to a buyer who doesn't want to buy. Time to not only think out of the box but to get out of it as well.
M2M may have been a boon to leverage at one time, but that doesn't justify burning down the house now. It was a poor idea then, still a poor idea.
You must be very smart to be that far ahead of the market! Are you a comedian?
If a change to mark-to-market has a positive psychological impact on the market, it is a good idea. Period. We are way beyond the point where ideological differences matter. What we need now is to take steps to insure that our financial system survives this crisis, and that investors regain confidence. If we have to suspend some rules in order to do this - then let's do it. Let's face it - this isn't an exercise in theoretical finance - it's the REAL WORLD!
I for one would rather see our economy recover, and listen to the critics complain about how we "kicked the can down the road", than to watch a complete collapse of our system, and listen to the purists tell us that we should be proud that we stayed true to our principals, and, By God, we should be able to recover within ten or twenty years.
For all you opponents of kicking the can down the road, remember - what we're talking about with these "toxic assets" is not much different than maintaining a margin account with your broker.
Suppose you have a $100,000 account, and you margin it out to purchase $200,000 worth of stock. Friday, you get a margin call from your broker, (who happens to be your brother in law) who tells you that you have a $3,000 shortfall. He tells you the money is due now, but, because you're married to his sister, he'll stall the margin department til monday. He just "kicked the can down the road". If, on Monday, the market is flat or lower, you have to cover the call, probably by selling some of your favorite stocks at a five year low. If the market goes up enough to cover the call, you're saved. If the market continues to improve, you have a chance to recover some or all of your losses. Your brother in law just kicked the can down the road and saved your @#$@.
I submit that "kicking the can down the road", risking collapse of our economy at some future date, beats the hell out of destroying our economy today.
There may be some justification for suspending MTM, but anyone who thinks THAT is the cause of the coming Depression should get a job with Mr. Forbes, the Treasury Dept. or as Robert Rubenron's house boy.
On Mar 15 04:07 AM jeandit75 wrote:
> Keep shorting XLF my friend, I'll buy your supply of sotcks. You
> have to understand that a temporary end to the M2M will stop the
> bleeding of banks. It means they can stop marking assets down and
> don't need capital injections anymore. It will stabilize the system
> for awhile. It will help them breathe and move to start doing business
> again. The real economy needs the banks to function well. Theses
> shares are currently climbing a wall of worry. What is interesting
> for me is people like you are still not believers. Once you start
> to understand the benefits of the change of those crazy accounting
> rules, people like me will have made a ton of money buying banks.
> Now, this does not mean that it is the end of the problems for banks.
> The credit outlook remains gloomy. But at least, banks will now have
> some flexibility to adjust to the environment instead of having to
> beg for capital from the government. For that simple reason, bank
> and insurance shares are due for a massive bear market rally.
How about listening to some of the few people who correctly (yes, we were early in most cases)laid out the EXACT events now happening. The ones who are telling you that "restoring the system" to the unstable bubble, or propping up home prices, is NOT what we should be trying to do. Yes, we should be trying to reduce foreclosures and make sure our fellow Americans are not hungry. We should not bail-out Criminal Bankers, Politicians from Both parties and useless, corrupt "regulators".
On Mar 15 03:07 PM User 366653 wrote:
> Some of the comments here are missing the only point that matters:
>
>
> If a change to mark-to-market has a positive psychological impact
> on the market, it is a good idea. Period. We are way beyond the point
> where ideological differences matter. What we need now is to take
> steps to insure that our financial system survives this crisis, and
> that investors regain confidence. If we have to suspend some rules
> in order to do this - then let's do it. Let's face it - this isn't
> an exercise in theoretical finance - it's the REAL WORLD!
>
> I for one would rather see our economy recover, and listen to the
> critics complain about how we "kicked the can down the road", than
> to watch a complete collapse of our system, and listen to the purists
> tell us that we should be proud that we stayed true to our principals,
> and, By God, we should be able to recover within ten or twenty years.
>
>
> For all you opponents of kicking the can down the road, remember
> - what we're talking about with these "toxic assets" is not much
> different than maintaining a margin account with your broker. <br/>
>
> Suppose you have a $100,000 account, and you margin it out to purchase
> $200,000 worth of stock. Friday, you get a margin call from your
> broker, (who happens to be your brother in law) who tells you that
> you have a $3,000 shortfall. He tells you the money is due now, but,
> because you're married to his sister, he'll stall the margin department
> til monday. He just "kicked the can down the road". If, on Monday,
> the market is flat or lower, you have to cover the call, probably
> by selling some of your favorite stocks at a five year low. If the
> market goes up enough to cover the call, you're saved. If the market
> continues to improve, you have a chance to recover some or all of
> your losses. Your brother in law just kicked the can down the road
> and saved your @#$@.
>
> I submit that "kicking the can down the road", risking collapse of
> our economy at some future date, beats the hell out of destroying
> our economy today.
Interestingly, people in their teens and Twenties are way ahead of us Boomers in seeing how illusery was the "wealth" of the past 2 decades- it really was just DEBT, not "liquidity" that fueled the whole will-o-wisp.
But those at the Top sure will keep those bonuses!
On Mar 15 12:19 PM vreporter wrote:
> "Without doubt, since fully-informed investors form only a small
> proportion of the capital markets, the spin and hype surrounding
> the “inherent evils” of the mark-to-market rule and Level 3 measurements
> could well take bank shares significantly higher this week."
>
> You must be very smart to be that far ahead of the market! Are you
> a comedian?
Check for yourself on Google.
What's different this time in addition to the negative sentiment extremes of March 6th is that the market is beginning to accept the panic phase is over. The impact of the combined efforts of the Treasury, the Fed and probable "adjustments" to M2M is convincing the market that the banking industry will be survive intact without the dirty N word. It's my opinion now that the typical saw-tooth pattern of stock prices has turned from a declining to an upward slope.
Having said that, if market is poised to move up, the second order effect of the M2M can provide a positive feedback loop this time:-) Perhaps they should leave it alone or fake tuning it to give market the kick.
On Mar 15 03:07 PM User 366653 wrote:
> Some of the comments here are missing the only point that matters:
>
>
> If a change to mark-to-market has a positive psychological impact
> on the market, it is a good idea. Period. We are way beyond the point
> where ideological differences matter. What we need now is to take
> steps to insure that our financial system survives this crisis, and
> that investors regain confidence. If we have to suspend some rules
> in order to do this - then let's do it. Let's face it - this isn't
> an exercise in theoretical finance - it's the REAL WORLD!
>
> I for one would rather see our economy recover, and listen to the
> critics complain about how we "kicked the can down the road", than
> to watch a complete collapse of our system, and listen to the purists
> tell us that we should be proud that we stayed true to our principals,
> and, By God, we should be able to recover within ten or twenty years.
>
>
> For all you opponents of kicking the can down the road, remember
> - what we're talking about with these "toxic assets" is not much
> different than maintaining a margin account with your broker. <br/>
>
> Suppose you have a $100,000 account, and you margin it out to purchase
> $200,000 worth of stock. Friday, you get a margin call from your
> broker, (who happens to be your brother in law) who tells you that
> you have a $3,000 shortfall. He tells you the money is due now, but,
> because you're married to his sister, he'll stall the margin department
> til monday. He just "kicked the can down the road". If, on Monday,
> the market is flat or lower, you have to cover the call, probably
> by selling some of your favorite stocks at a five year low. If the
> market goes up enough to cover the call, you're saved. If the market
> continues to improve, you have a chance to recover some or all of
> your losses. Your brother in law just kicked the can down the road
> and saved your @#$@.
>
> I submit that "kicking the can down the road", risking collapse of
> our economy at some future date, beats the hell out of destroying
> our economy today.
> you guys who think the mark to market is good need a reality check..do
> you really like what is happening to the economy and the banks,i know you shorters do and i hope also you get caught in a big loss.
====================
Shorters are too few to have any influence. Remember the short ban? I was prevented to short a stock just on the day it was added to the short ban list that I had consulted before placing my order.
Even my broker could not find this stock on his list, but assumed it was it the same batch.
Then I helplessly watched the stock moving down exactly as before the ban.
The banks have pulled the whole world go through this crisis, why should not one want to recuperate a part of the losses? Do you think bank never short? They pay exceptional traders to buy or sell to increase their liquidities. They were caught badly, and I do not think that the only reason why the banks failed so much are the "toxic asset" of housing bad loans: I am sure that they lost a lot when the commodities and futures dropped abruptly.
And now it's up to all citizens to provide them with the liquidities they lost?
I too can get caught any time, except that the M2M applies to shorts but not to stocks held true the down slope. But if I get caught, no one is going to come to bail me out!
I am "happyshorter"? I would much prefer to be a "happyinvestor", and be long instead of short.
But I lost enough: don't they say "ride the wave!"?
Big institutions can influence the course of a stock, not individual investors. Big Mutual funds created your "misfortune" when they sold, but maybe they protected others from a still bigger misfortune.
Do not blame the shorters, blame your-self if you did not sell when it was time to check your holdings.
And let the shorters try to bail them-selves out.
BTW:
Do you really think shorters can prevent jobs to be created?
On Mar 15 05:30 PM mattm wrote:
> I'm praying for the day when you shorts get burned big time. I urge
> you to keep shorting. Please put your maximum net worth into shorting.
> I can't stand the shorts trying to spread doom and gloom to try to
> make people more fearful than they already are. I know that revenge
> is not very spiritual; however, I am human--and I hope you lose all
> of your wealth. That will be a happy day for me. Mark my words: you
> will not gain by hoping for destruction of the American economy.
I'm not Rick Santelli .... I don't rant! I know I can't influence the market ...
Good luck trading ...
TaurusTrader
www.taurustrader.wordp...
TheValueatRisk.blogspo...
Buffet has said things and done a few mistakes.
And because almost everyone in this country thinks that he is an investment super model, he can use his words to influence the market in the direction he wants, one of the very few who can, at least on the short term.
On Mar 16 01:39 PM dividendgrowthinvestor wrote:
> As an accountant i TOTALLY disagree
>
> Buffett said last week the toxic assets are the MOST valuable at
> these price levels
>
> Once the vultures realize the banks arent selling the market will
> rally
Mr. Saxena is getting quite a bit of pushback on this article. Check his record. Read his other articles. Put him on your watchlist. He has been right on the money for many months. He must have made a fortune on his shorts.
Mr. Saxena also understands derivative contracts and their impact on the financial firms. So disagree with him if you like but you should know that this writer is well informed.
Personally, I think that we are at the point that our leaders believe that it is imperative to create the illusion of a recovering economy. (Witness Bernake, Obama of late.) That illusion may, in fact, be what is needed to restore confidence long enough to make it across to the other side. Additional losses will come, they realize, but may be able to be absorbed by a rebounding world economy.
This reminds me of the Latin American debt crisis of the late 70's early 80's. We allowed the banks time to write off their bad loans which saved the system. The illusion worked in that case.
On Mar 15 03:01 AM ccerenz2 wrote:
> This author clearly doesn't understand the negative downward pressure
> that Mark to market has on assets in a declining market.
Regards,
www.saibposervices.com...
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