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Warts on a Balance Sheet: Asset Valuation Remains Troubled
That heart is still malfunctioning. Asset pricing – and we are talking about CDS, CDOs, other derivatives, etc. – practices continue to wander in the wilderness.
I was convinced that banks are very, very far from able to price assets accurately after attending a panel discussion sponsored by the Risk Management Association’s New York chapter this week. The situation is not good.
The key point – the one that showed the warts on the apple – was delivered by Daniel Sullivan, the deputy manager of the Market Risk Management Department at the Federal Reserve Bank of New York. Sullivan “is
Culture?!? So let me get this straight, a “best practice” in asset valuation is making sure that the C-suite does not “influence” the results?!? Presumably – and remember, this is coming from the person who is responsible for the oversight of all the valuation examinations in the New York Fed’s district, arguably the nation’s most important – senior bank executives are still “influencing” asset valuations, which are themselves continuing to be subject to bank “culture.” This, to me, is shocking. We are talking about the price of assets. That Sullivan could not express a hard and fast methodology as a best practice means that there is none, that the Federal Reserve has allowed asset valuation to remain an artistic endeavor for bankers and traders.
Let’s take this a step further. If asset valuation remains an art, then the artists cum bankers can “paint” as they wish. If market participants “feel” that assets should plummet in value again, then plummet they will. If market participants collectively choose to buttress an asset’s price (as they are today), then buttressed it will be. Forget formulas, forget fair value, forget mark-to-market. Have we learned nothing in the last 12 months?
“At the Fed, we would like to see more data in valuation,” Sullivan said.
Uh, yeah.
To be sure, some of the other practices spelled out by this panel reveal additional ugly truths about asset valuation. For example, Roger Curylo, senior vice president, credit risk, at Fidelity Investments, said it was not the case that all asset valuations are done with “multi-source pricing,” meaning that multiple price quotes are used to formula a valuation. Rather, some banks still opt for “single-source pricing.” If that was not disturbing enough, Curylo went on to say that, as for a “best practice,” it was not enough to use multi-source pricing, “but how do you pick [the sources]? You don’t want to cherry pick.” Cherry picking for asset valuation – ugh.
The regulators deserve some of the blame for this mess. Another of the panelists (the best one, in my opinion), Barbara Matthews, principal at BCM Strategies, a Washington, D.C., consultancy, explained bluntly how the international regulatory bodies have gone back and forth on suggested valuation practices that effectively banks have no idea what to do now. Think about this. Not every bank around the world uses fair-value accounting. Does the Basel Committee favor it? Not really. But don’t tell that to the American regulators, because they’ve throw it at the US banks.
“Policy is all over the map,” Matthews said. “Many assets will have different accounting rules within two years.”
That, in and of itself, is problematic for those banks trying to nail down a consistent valuation methodology.
So what to do? Are the regulators really MIA? The New York Fed’s Sullivan offered a glimpse at how the regulator is handling the situation. It is true that the Fed cannot articulate a definitive methodology, but Sullivan hinted that it doesn’t have to. What the Fed has increasingly told banks is, “You believe [a specific asset] is worth this much? Then sell it,” Sullivan said.
How much “selling” is going on is another discussion entirely.
Why Bair Will Lose Her Fight with Geithner
The pitched battle over regulatory reform essentially boils down to two perspectives. There is the Geithner camp that argues systemic risk should be monitored and minimized when it pops up. And there is the Sheila Bair camp that says the prospect of concentrated systemic risk should be eliminated before it has a chance to surface, much in the way Teddy Roosevelt eliminated the opportunity for trusts to surface.
Whichever side you agree with (I favor Bair's) matters little, because the ultimate winner will be crowned not on merit, but on another factor: access to President Obama.
This week The New Yorker published an interested, if flawed profile of Sheila Bair, the chairwoman of the FDIC. Beyond the article's main, glaring shortcoming (it doesn't acknowledge that Bair had a part in failing to prevent the subprime mortgage meltdown), it raises an interesting detail about Bair's access to Obama:
As the head of an independent agency far from the West Wing’s inner circle, Bair has limited access to the President. She has met with him privately just once this year, on Air Force One, returning from an event in Arizona where he announced his mortgage-relief plan, modelled on the loan-modification ideas that Bair had long advocated.
Bair has, in fact, attended other meetings with the president and his other advisors, but still it is clear that Bair has little access to Obama. John Dugan, the Comptroller of the Currency, too has met with Obama only a few times.
Not Timothy Geithner. He meets with president, face to face, almost daily. I get the Treasury Department's daily schedule for Geithner. Almost everyday the following appears at the top of the list:
On [INSERT DAY HERE] morning, Secretary Geithner will attend the President’s Daily Economic Briefing at the White House. This meeting is closed press.
Bair is well outside the loop -- and no policy argument can overcome that, which is why Obama's proposed regulatory reform schema looks like it was written by Geithner, with only margin comments from Bair. Why else would the Federal Reserve, the propagator of systemic risk, be assigned with the job of monitoring systemic risk?
You know what they say about real estate? Location, location, location. The same holds true in Washington, DC, politics.
Disclosure: no positions