FASB: Don't Throw Me in the Briar Patch

A couple of reports last week warn that the end is near for the banking industry as the FASB prepares to restore some mark-to-market criteria for bank reporting. This is truly silly. Mark-to-market neither hurts nor helps the banks, but exactly the opposite. It makes their earnings more volatile and pro-cyclical. At the beginning of this year I fulminated against FAS 157 and its pro-cyclical effects on banks. Giving banks flexibility on marking portfolios at extreme levels of distress helped stabilize the financial system, even though it had little net effect, as asset prices recovered from their extreme lows.

There’s nothing more annoying than a journalist (or blogger) with an idea, the idea being in this case that ending mark-to-market was a giveaway to the evil bankers. Here’s Jonathan Weil in Bloomberg:

July 23 (Bloomberg) — Turns out America’s accounting poobahs have some fight in them after all.

Call them crazy, or maybe just brave. The Financial Accounting Standards Board is girding for another brawl with the banking industry over mark-to-market accounting. And this time, it’s the FASB that has come out swinging.

It was only last April that the FASB caved to congressional pressure by passing emergency rule changes so that banks and insurance companies could keep long-term losses from crummy debt securities off their income statements.

Now the FASB says it may expand the use of fair-market values on corporate income statements and balance sheets in ways it never has before. Even loans would have to be carried on the balance sheet at fair value, under a preliminary decision reached July 15. The board might decide whether to issue a formal proposal on the matter as soon as next month.

And Daniel Indiviglio at the Atlantic:

Attention: This may be the single most important piece of news regarding the financial industry you will read this week. Maybe for the whole month. Maybe for the whole year. Okay I’ll stop being melodramatic and get right to it. The Financial Accounting Standards Board (FASB) is in the process of making banks very unhappy. In a complete reversal from their revised policy released in April, it is considering vastly tightening mark-to-market requirements to include virtually all securities on a bank’s balance sheet. Yes, it even wants the very, very illiquid stuff marked-to-market.

It was amusing to see Indiviglio’s readers tear him up in the comments section of the linked report.

If these characters bothered to check asset prices, they would see that a shift to mark-to-market actually would show an increase in bank earnings. Banks in general are using very conservative marks for asset prices, as a buffer against expected loan losses to come.

Comments

[Marli:]

Marking to market may increase volatility, but with the additional bonus of transparency. A balance sheet is supposed to be a snaposhot of company's position at a moment in time - as well as overall market conditions for that particular industry. Excessive leeway in pricing these assets is the equivalent of reporting this year's earnings statements in 'constant currency' terms in order to mask the effects of adverse foreign exchange movements.

In the name of smoothening out the time series, we now have less reliable information upon which to base fair-value calculations. The FASB relaxed 157 in the midst of severe pressure and what seemed to be an extremely fragile environment, but they knew deep down that in so doing they have compromised GAAP standards. Now that the environment for capital formation is far more favorable now than it was then, they are revoking what was always meant to be a one-time concession.

Aug 03 08:28 AM

[Henry Buttal:]

I disagree Marli. The 157 modification was protested by the banks almost from the beginning. The requirements were to be too broadly applied, as the Board has a poor history of targeting changes with a shotgun, not a rifle.

As a sometimes expert witness in financial valuation cases, I often hear a debate over what defines a willing buyer-willing seller. A company forced to sell an asset to ensure ongoing existence is not a willing seller, and is not in a position to demand fair value for the asset. It is a liquidation sale.

157 forced any company valuing assets to do so at the lowest value, which was often the liquidation value. I don't understand how enforcing such an accounting artifact can in anyway help in valuing an ongoing business.

Aug 03 11:21 AM

[predictorma...:]

FASB has always been an interesting interface between business interests (and their VENDORS, the accounting firms) and investors.

The SEC stands right behind the FASB and can make them change their minds. As we all know the SEC's tack changes with the administration, but this administration (especially as concerns the banks) certainly is very close to big money interests.

Like physics, accounting rules seem to exist in a parallel universe, not in the real world. I am cognizant of the difficulties the FASB faces in accounting for very complex transactions. However, the obtuse nature of their pronouncements (even on sometimes simple issues) means that they can be read in a variety of ways.

With all the ways that companies report (pro forma, non-financial statement metrics, etc.), and the way investors make decisions, I don't think that most new accounting rules make much of a difference.

Aug 03 11:26 AM

[msgtb:]

It is clear that the mark to fantasy changes allowed the banks to show a paper profit. TThey should have offloaded the bad debts on their books instead they continue to pursue this fools game. They are still insolvent and everyone knows that. This is a fantasy rally and without traders and legal shorts under this market we may soon get to test the market circuit breakers.

Good luck and good trading

Dave

Aug 03 11:54 AM

[Tack:]

It's utterly amazing how few understand mark-to-market accounting, which powerful forces control its actual impact and its deleterious effects, given unregulated trading.

Mark-to-market accounting transforms accounting practices and valuation methods that have been refined by accountants and auditors for decades, even longer, into a daily gambling parlor, where asset prices are set by traders, whose ineterests are often aligned precisely with the failure of the institutions holding the assets being valued.

That's the reason why the ABX index was created by Goldman Sachs, so this thinly-traded index could be used as a proxy for the valuation of assets on banks' books, without any regard to how those underltying assets might be performing. Then, Goldman (just one player among many) took out huge (naked) short-stock positions and multiple (since they were not regulated) CDS contracts on the debt of the various companies, whose debt assets they were concertedly shorting into oblivion. Mark-to-market accounting just ensured that those banks, and others, had no choice but to value the assets at the artificial values created by these huge shorting machines with and agenda.

None of this had the remotest thing to do with the actual intrinsic value of the debt assets, based of time-proven methods of discounting debt, based on its underlying performance. Mark-to-market makes accounting and auditing irelevant.

Now, the last bastion of assets --loans held to maturity and/or not-for-sale-- which were not open to this obvious manipulation game, are threatened by the FASB to be thrown into the good ol' debt-shorting, CDS, gaming parlor. For a beginning-to-recover financial system, this is a suicide wish, as we'll start the old cycle -- debt shorting begetting writedowns, begetting falling share prices, begetting fear, begetting crisis and economic turmoil, etc.-- all over again.

Let's hope somebody's sane in the room, somebody with influence and power.

Aug 03 09:47 PM

[Old Trader:]

"Banks in general are using very conservative marks for asset prices, as a buffer against expected loan losses to come."

Perhaps I'm being overly simplistic, but this sounds to me like "managing earnings", which is generally viewed as a "bad thing".

Aug 03 10:44 PM