Banks Seeking To Value Assets Higher Than Market Value

[KC]

Banks (http://consumerist.com/tag/banks/) are pushing for a change to banking rules (http://consumerist.com/tag/banking-rules/) that would allow them to ignore mark to market accounting (http://www.huffingtonpost.com/2009/03/26/new-rule-would-allow-bank_n_179489.html) for assets in markets that they deem "inactive." In other words, if a bank is loaded with worthless assets but decides that the market for those assets is frozen, they can value those assets higher than the market would. Or to simplify it even more, they can create value out of toxic assets. And it looks like now the Financial Accounting Standards Board, which so far has been against this rule change, is caving in.

The Huffington post points out that this is an abrupt about-face for the FASB:

The move marks a shift for Robert Herz, head of the FASB, who recently told a panel of lawmakers that the harshest critics of mark-to-market accounting practices have been the very same banks (http://consumerist.com/tag/banks/) that have gone under when regulators would not let them adjust their accounting. Herz and other regulators have been under intense congressional pressure to reform the rules.
"I will tell you that I get calls and visits from some of those institutions that are now in government hands, about two weeks before they get taken over, trying to get the accounting changed," he said. "Clearly some of the most vocal opponents of fair value and mark-to-market have been some of those institutions that ultimately failed and have had to have billions of taxpayer dollars put into them."
FULL STORY (http://consumerist.com/5186166/banks-seeking-to-value-assets-higher-than-market-value)

[Die Neue Zeit]

Given my educational background, what a double standard! :cursing:



I don't see much information [I]relevance here (the basis of market-value accounting), much less information reliability (historical-cost accounting, which is being sacrificed slowly by international accounting).

[MarxSchmarx]

I don't see much information relevance here (the basis of market-value accounting), much less information reliability (historical-cost accounting, which is being sacrificed slowly by international accounting). _______________

Sorry to be such a n00b about this, but how then would one account for the fact that the market is "frozen" and rather anomalous in the pricing?

[Psy]

Sorry to be such a n00b about this, but how then would one account for the fact that the market is "frozen" and rather anomalous in the pricing?

Because they are holding claims on debt that they bought from another party that issued the debt. In this market no one knows how many debts would default and holding claim to a debt that defaulted is worthless, this puts the exchange value of claims on debt into question.

[KC]

Sorry to be such a n00b about this, but how then would one account for the fact that the market is "frozen" and rather anomalous in the pricing?

Well that's the very reasoning behind it. The banks are arguing that mark to market is unfair because the markets for these toxic assets are frozen. The problem, though, lies in the consequences of letting the banks value their own assets:


If banks are allowed to determine the value of their assets without regard to current prices, investors have less trust and confidence in the integrity of their books and their assets, which could further freeze markets and further drive down prices.

[KC]

Here's Bloomberg's take on it, a little more recent, and with a little more info on how profound this policy change actually is:


March 30 (Bloomberg) -- Four days after U.S. lawmakers berated Financial Accounting Standards Board Chairman Robert Herz (http://search.bloomberg.com/search?q=Robert%0AHerz&site=wnews&client=wnews&proxystylesheet=wnews&output=xml_no_dtd&ie=UTF-8&oe=UTF-8&filter=p&getfields=wnnis&sort=date:D:S:d1) and threatened to take rulemaking out of his hands, FASB proposed an overhaul of fair-value accounting that may improve profits at banks such as Citigroup Inc. (http://www.bloomberg.com/apps/quote?ticker=C%3AUS) by more than 20 percent [emphasis mine].



The changes proposed on March 16 to fair-value, also known as mark-to-market accounting, would allow companies to use “significant judgment” in valuing assets and reduce the amount of writedowns they must take on so-called impaired investments, including mortgage-backed securities. A final vote on the resolutions, which would apply to first-quarter financial statements, is scheduled for April 2.



...



By letting banks use internal models instead of market prices and allowing them to take into account the cash flow of securities, FASB’s change could boost bank industry earnings by 20 percent, Willens said. Companies weighed down by mortgage- backed securities, such as New York-based Citigroup (http://www.bloomberg.com/apps/quote?ticker=C%3AUS), could cut their losses by 50 percent to 70 percent, said Richard Dietrich (http://search.bloomberg.com/search?q=Richard+Dietrich&site=wnews&client=wnews&proxystylesheet=wnews&output=xml_no_dtd&ie=UTF-8&oe=UTF-8&filter=p&getfields=wnnis&sort=date:D:S:d1), an accounting professor at Ohio State University in Columbus.
“This could turn net losses into significant net gains,” Dietrich said. “It may well swing the difference as to whether bank earnings are strong this quarter, or flat to negative.”

‘Unintended Consequences’



Citigroup (http://www.bloomberg.com/apps/quote?ticker=C%3AUS) had $1.6 billion of losses last year for so- called Alt-A mortgages, according to the company’s annual report. That loss would be erased with the new FASB rules, Dietrich said.



Bank of America Corp. (http://www.bloomberg.com/apps/quote?ticker=BAC%3AUS) in Charlotte, North Carolina, reported “income before income taxes” last year of $4.4 billion. The FASB proposal on impaired securities would increase that figure by about $3.5 billion, or the amount of “other- than-temporary” losses that the company recognized, Dietrich said. The new rule would mean the loss would be stripped out of net income, boosting earnings, though it would still be reported in financial statements.



...


While helping lenders report higher earnings, FASB’s changes may hurt Treasury Secretary Timothy Geithner (http://search.bloomberg.com/search?q=Timothy+Geithner&site=wnews&client=wnews&proxystylesheet=wnews&output=xml_no_dtd&ie=UTF-8&oe=UTF-8&filter=p&getfields=wnnis&sort=date:D:S:d1)’s plan to remove distressed assets from bank balance sheets, Dietrich said. Allowing companies to hold on to assets without writing them down could discourage them from selling the securities, which would work against Treasury’s objective to resuscitate markets, he said.


(http://www.bloomberg.com/apps/news?pid=20601109&sid=awSxPMGzDW38&refer=home)
Full Story (http://www.bloomberg.com/apps/news?pid=20601109&sid=awSxPMGzDW38&refer=home)

[Die Neue Zeit]

Sorry to be such a n00b about this, but how then would one account for the fact that the market is "frozen" and rather anomalous in the pricing?

From what I learned in my studies, even in the best-case scenario of relevance and reliability, financial accounting information pertaining to publicly traded corporations "accounts" for only 5% of market price movements (hence "anomalous"), which in turn are based at best on a weak-form of the efficient market hypothesis (past performance not affecting future price movements).

[MarxSchmarx]

Because they are holding claims on debt that they bought from another party that issued the debt. In this market no one knows how many debts would default and holding claim to a debt that defaulted is worthless, this puts the exchange value of claims on debt into question.

Isn't this in principle something that could be found out by tracing what the debts are and the books of the debtor as of now prior to the transaction?



Well that's the very reasoning behind it. The banks are arguing that mark to market is unfair because the markets for these toxic assets are frozen. The problem, though, lies in the consequences of letting the banks value their own assets:

If banks are allowed to determine the value of their assets without regard to current prices, investors have less trust and confidence in the integrity of their books and their assets, which could further freeze markets and further drive down prices.


By letting banks use internal models instead of market prices and allowing them to take into account the cash flow of securities, FASB’s change could boost bank industry earnings by 20 percent, Willens said. ...
“This could turn net losses into significant net gains,” Dietrich said. “It may well swing the difference as to whether bank earnings are strong this quarter, or flat to negative.”



I see that illuminates the crux of the debate. Still, this strikes me as going too far in the other direction. There is dynamism in the market price which doesn't seem accurately reflected, but letting banks develop their own internal models and using those as the standard is just way too subjective; one wonders why they don't search for a middle ground.




From what I learned in my studies, even in the best-case scenario of relevance and reliability, accounting information "accounts" for only 5% of market price movements (hence "anomalous"), which in turn are based at best on a weak-form of the efficient market hypothesis (past performance not affecting future price movements).


So you were basically mocking the "relevance/reliability" dogma in your post? If so, that makes sense, I agree it seems silly to only account for such small devaluations of market prices.

[Die Neue Zeit]

Yeah, I was pretty much mocking it. :D

[Nevertheless, financial accounting information should be as reliable and as relevant as possible for private corporations. Meanwhile, how the bloody hell is "comprehensive income" (http://en.wikipedia.org/wiki/Comprehensive_income) relevant for me (much less reliable)? :glare: ]

[Psy]

Isn't this in principle something that could be found out by tracing what the debts are and the books of the debtor as of now prior to the transaction?

These claims on debt were rated secure prior to the crisis meaning capitalists can't trust the auditors as it is now obvious auditors rate risk what their bosses say to rate them that means other capitalists can't trust the rating of debt.

[Die Neue Zeit]

Can I venture to introduce audit terminology, then? :D

[Psy]

Can I venture to introduce audit terminology, then? :D
The beginning of part 2 of the comedy skit Bird & fortune - Financial crisis (Part 1 (http://www.youtube.com/watch?v=lWDdcD-1xoo),Part 2 (http://www.youtube.com/watch?v=ScwGBNMH428)) does a good job of poking fun at the auditing of debt.

[MarxSchmarx]

These claims on debt were rated secure prior to the crisis meaning capitalists can't trust the auditors as it is now obvious auditors rate risk what their bosses say to rate them that means other capitalists can't trust the rating of debt.But this is only insofar as the capitalists rely on external auditors for judgment calls. Which, I realize, is how it goes down in practice. Well, at least that's how I always thought it worked.

If, however, they rely on internal auditors (i.e., their employees) then, again, if the internal auditors do their job they should recommend against such purchases even though the external auditors give the green light. Or so, I would guess, would be the case at least in principle if the internal employees who look at the books are competent and know what they are doing.

Again sorry if I'm confusing things, I don't know anything about accounting except balancing my own checkbook. I can barely file my taxes as it is :D



Nevertheless, financial accounting information should be as reliable and as relevant as possible for private corporations. Meanwhile, how the bloody hell is "comprehensive income" (http://www.anonym.to/?http://en.wikipedia.org/wiki/Comprehensive_income) relevant for me (much less reliable)? http://www.revleft.com/vb/../revleft/smilies2/glare.gif

Wouldn't these same standards be important for economic planning? Even comprehensive income (the extent of my knowledge being the wikpedia page you linked to) would seem like useful information, because it identifies the scale of certain planned enterprises. But back to your first point, wouldn't reliable and relevant information be the cornerstone of planning even for publicly owned enterprises?

[Die Neue Zeit]

But this is only insofar as the capitalists rely on external auditors for judgment calls. Which, I realize, is how it goes down in practice. Well, at least that's how I always thought it worked.

Yeah they do. There's a helluva lot more onus on auditors and their "professional judgement" after the passage of Sarbanes-Oxley.


Again sorry if I'm confusing things, I don't know anything about accounting except balancing my own checkbook. I can barely file my taxes as it is :D

No worries. All this accounting stuff can't be disinteresting.


Wouldn't these same standards be important for economic planning? Even comprehensive income (the extent of my knowledge being the wikpedia page you linked to) would seem like useful information, because it identifies the scale of certain planned enterprises. But back to your first point, wouldn't reliable and relevant information be the cornerstone of planning even for publicly owned enterprises?

"Comprehensive income" is something so relatively new GAAP-wise that I didn't get to learn it. That's the frustrating part. :(

As for your last question, yes indeed. I'm sure there are government accounting standards that take into consideration the relevance vs. reliability tradeoff, but at least there are no market price distractions.