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Another Perspective
Let's Not Forget the Accountants
Has the easing of mark to market rules made the Treasury Department's job more impossible?
What can you say about a 17-year-old accounting rule that died? That it was beautiful?
Accounting has always been a boring subject to many people. Nevertheless, Financial Accounting Standards Board (FASB) 107, a twenty-nine page document, is emerging as analytical ground zero in the battle to fortify bank balance sheets and stimulate the flow of credit -- and jump start the economy as a whole.
Accounting, as we know it today with double entries of debits and credits, is acknowledged to have antecedents dating to the Italian Renaissance. But one must doubt that the accountants of antiquity envisioned accounting architecture to destroy financial markets like a neutron bomb, leaving no stock exchanges and only blank general ledgers.
The mark to market principles of FASB 107 have helped bring the entire world to the edge of an abyss, in which lurk financial monsters and creatures of doom, unseen for several generations.
As the global financial crisis has played out 24/7, and the secondary market for collateralized debt obligations (CDOs) and more specifically mortgage backed securities has seized up, there are few, if any investors to be found, since they have run for the exits. This lack of investors has resulted in colossal losses due to the need of the banks and investment banks to mark to market their asset portfolios, in accordance with FASB 107. Never mind that some securities had unimpaired cash flows and were performing as agreed -- or that there was no market to mark to.
FASB 107 contemplates an immediate and disorderly sale environment -- what is the price if you have to sell an asset NOW? It would be like having to write your house down to a fraction of its earlier market value, so that you could sell it in a matter of minutes, electronically on eBay perhaps, or while riding on public transportation, or maybe just to the next passerby.
After the global banking system has been brought to its knees in part by the law of unintended consequences, the accounting industry has now, after the destruction of about $50 trillion of private capital in global terms (source: Asian Development Bank), decided to modify FASB 107. The intent is to be more benign to banks and to allow for valuations based on more orderly liquidation circumstances. Given this protracted global crisis, and the many cries for reform of mark to market over more than a year, it raises the question of why it has taken so long to modify FASB 107.
While this accounting change would at first sight seem to be welcome news, by now allowing banks to value mortgage-backed securities and CDOs at prices reflecting orderly disposition and presumably intrinsic cash flows, it may make the Treasury Department's job harder in conducting private/public sector auctions. The point of the Treasury Department's most recently announced initiative to acquire at least $500 billion of distressed assets is to bring many sellers and investors together -- with minimal equity from private sources, and debt financing guaranteed by the FDIC.
Because of this modification of FASB 107, banks will now be able to carry such assets at higher valuations, and bottom fishing investors may not wish to bid so high. So the very process of market making to relieve the banking sector of toxic assets, encourage resumed credit flow, and facilitate global recovery is now potentially undermined.
For the worst financial crisis in many decades, as long as the nation is blaming Fannie Mae, Freddie Mac, the Federal Reserve, the Bush Administration, AIG, the banks and investment banks, unregulated mortgage banks and brokers, rating agencies, government regulatory authorities, Congress, populist laws that support without recourse mortgage financing, the media, the Community Reinvestment Act, rampant greed, and those folks leveraging up with bad judgment on Main Street, we need to add yet another group -- the accountants.
The only trouble is that it may be too late in the world for accounting entries.
About the Author
Frank Schell is a business consultant and former international banking executive. He serves on the Dean's International Council of the Harris School of Public Policy Studies, University of Chicago, where he is a guest lecturer, and on the editorial board of the Chicago-based National Strategy Forum, which focuses on national security issues.
Letter to the Editor View all comments (19) | Leave a comment
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Jeff Mahoney| 4.15.09 @ 8:30AM
Frank,
Accounting did not create the crisis, accounting is simply reporting the results of the poor decisions that your former colleagues (and others) have made. More fair value accounting, not less, is needed to assist us in understanding the extent of the problem and taking the steps necessary to resolve this crisis in a timely manner. Read some history about the "lost decade" in Japan and you will find that many, if not most, financial experts agree that that crisis would have been resolved much more quickly and at a lower cost if the Japanese financial institutions had more quickly recognized the fair value losses in their loan portfolios rather than hiding the information from public view. Let's hope we do not repeat their mistake.
Doug Kimball| 4.15.09 @ 10:11AM
The problem lies not with accoutants, but in the creation and trading in arcane and esoteric financial instruments that cannot be regularly evaluated on their underlying financial merits. There are no annual reports for CMO portfolios, no crop reports, no historical pricing history, no rating agency evaluations. Yes, we can wrap our heads around the underlying economics, but to create, account for and report on the underlying economics, but to do so would come at such cost, it would render the ROI on such instruments so low as to make them unattractive. So we skipped a step and ignored reporting on the portfolios, and now we not only have no mechanism for evaluating the underlying economics (read:performance and collateral value), but we have no mechanism for forclosure, resale, asset deployment, leasing - all the requirements of one in the mortgage lending business. We used to have this mechanism - S&L's - but they were eclipsed, stripped of capital to lend, with the rise of market returns on ready cash investments, namely money market funds.
Joe| 4.15.09 @ 11:46AM
Frank, I resent that. I am an Accountant, and along with most accountants, had nothing to do with FASB 107 or even agreed with it.
bill| 4.15.09 @ 1:36PM
what a bunch of self serving nonsense. you bankers bear a tremendous portion of responsibility in foisting worthless debt instruments on the world.
jerk
Avitar| 4.16.09 @ 12:20AM
There really is not a way to get a large engineering job done with mark to market. The same is true for most large borrowings.
aware| 4.16.09 @ 6:54AM
If I had a large inventory of brand new two horse wagons, what would they be worth? I could look at the cost of resources (wood, labor, etc.) it took to build them or should I look at the demand for two horse wagons?
The former tells me they are worth at least the cost of the resources and therefore have "value". But the latter tells me, since there is no market for the product, that this is a malinvestment and is worthless. Which is reality?
All you have to know about this is that the banksters want so called "mark to market" done away with. Then they can set the value of their "investments" in ways other than what the actual sell of these "assets" brings.
This will encourage inflated valuation of assets, and through creative accounting, actually turn debts into assets. Instead of mark to market you will get mark to myth and light the fuse to a bigger time bomb than the one that just went off.
Finding more creative ways to cook the numbers is not improving the fundamentals. It only highlights the institutional corruption at the core of this debacle. As long as this kind of denial rules you can only expect this to get worse, much worse.
johnmayer| 4.21.09 @ 6:10AM
It is estimated that Obama's plan could benefit 8 to 9 million homeowners from the new modification procedures. So how do you know you qualify for the Mortgage Modification? Check the website http://obamamortgage2009.blogspot.com/
to see if you qualify. I was also in trouble and I am glad I did check it before I talk to my mortgage company and it helped - John Mayer, California
johnmayer| 4.23.09 @ 6:41AM
It is estimated that Obama's plan could benefit 8 to 9 million homeowners from the new modification procedures. So how do you know you qualify for the Mortgage Modification? Check the website http://obamamortgage2009.blogspot.com/
to see if you qualify. I was also in trouble and I am glad I did check it before I talk to my mortgage company and it helped - John Mayer, California
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