Congress Pushes M2M Reform: Suspension Unlikely, Revisions Guaranteed

Includes: BAC, C, GS, JPM, WFC, XLF
by: Hiland Doolittle

U.S. Nears Mark-to-Market Accounting Guidance

An unrelenting panel from the House of Representatives forcefully pursued modifications to the current mark to marketing accounting guidelines imposed by the Securities and Exchange Commission. Appearances before the Financial Services Subcommittee of the House, chaired by Paul Kanjorski, were made by SEC chief accountant James Kroeker, Financial Accounting Standards Board Chair Robert Herz and Treasury Secretary Timothy Geithner.

Citing the lack of mark to market reform, Kanjorski delivered a pointed message declaring, “Such action is long overdue. If FASB and the SEC refuse to use their authority to provide useful and timely guidance, this Congress may have no choice but to act in their place.”

When pressed, FASB Chairman Herz agreed to respond to the subcommittee with recommended revisions within a three-week timetable established by Kanjorski. FASB is charged with establishing the accounting standards while the SEC is charged with enforcing those standards.

On Tuesday Federal Reserve Chairman Ben Bernanke voiced support for the FASB and the SEC but pushed for modifications to the existing system of valuing “toxic” assets. On Thursday, Treasury leader Geithner said, “we are in a period where investors do not have confidence in their capacity to judge risks. We have to be very careful not to do things that would erode confidence in people’s ability to assess the risks.”

At Stake - Public Trust

Bernanke, Geithner and Congress are well aware of the impact the current mark to market accounting system has had on the economy and the credibility of the U.S. financial institutions. Mark to market accounting is defended by investor advocacy groups but portrayed by financial institutions as unrealistic and punitive.

The FASB rebutted criticism for the mark to market evaluations stating, “some people are not exercising as much judgment as they could in valuations used by financial institutions. Supporters of the financials stress that time is of the essence in clarifying mark to market standards.

SEC Chairperson Mary Schapiro pushed for expanding the SEC’s authority to include the right to regulate hedge funds and recommending these funds be inspected by agencies. Schapiro also advocated that hedge funds be required to reveal trading policies and investment activity to the SEC.

Schapiro also addressed the Depression law expired in 2007 that regulated short seller activity. Schapiro indicated a proposal was imminent. Schapiro’s testimony warned Congress that more funds were necessary to enable the expansion of the SEC’s regulatory wing.

While Geithner, Bernanke and Schapiro have different roles, it seem government policy is determined to permit some flexibility in valuing distressed assets but is also determined to increase oversight and investment regulation to protect the public. These developments were well received by the marketplace and financial stocks surged in response.

The Private Side – A Different View

Putnam CEO Robert Reynolds put it simply; “The suspension of mark to market accounting would really help the markets.” The requirements of the law have forced financial institutions to substantially devalue the toxic assets, which, in turn, have dramatically hurt corporate balance sheets.

Reynolds told a group of businessmen “balance sheets are getting artificially hit when they should not be.” Reynolds went further stating that the low evaluations have caused panic in the marketplace and that banks and financial companies should be able to re-examine the toxic assets.

Critics agree that permitting some mark to market flexibility would boost the financials but these critics stress the need for transparency. Properly valued assets should invoke investor confidence, an absent commodity of late.

The leader of a $96 billion investment company, Reynolds also attacked government support for ailing AIG. “Let them go, absent a plan of how to get out of this situation. And, coming back every quarter for money is not a plan.”

This view was opposed by Secretary Geithner who has stated that sustaining AIG is vital to the American taxpayer. Geithner supports a timely restructuring of the lumbering albatross.

Reynolds went further. He pushed for nationalization of the banks, reorganization of the major financials and quick privatization after a brief stabilization period. Many feel this is where Geithner’s banking institution stress tests are headed.

Where Are We Headed?

While suspending the mark to market accounting system is unlikely, there is little doubt that revisions will be on the Congressional floor within three weeks. Revised procedures will should in force in the second quarter of 2009.

Schapiro’s push for more regulation of financials was well received. Congress appears to be supporting increased funding for regulatory controls. Bernanke and Geithner appear to be in favor of a system with more balance and that reduces the influence of mark to market fluctuations on the markets.

Investors want clarification. The time has come to implement change in mark to market accounting, set the appropriate regulatory controls in place and insist on transparency. Investors need to know what they are buying and how it is valued.