Both Treasury Secretary Timothy Geithner (left) and Federal Reserve Chairman Ben Bernanke (center) have commented recently on the 'mark-to-market' rule. Mr. Geithner said he had reservations about some of the proposed changes, and Mr. Bernanke noted that it's 'a very difficult question.' They are shown here at a congressional hearing last month on another subject.
(Kevin Lamarque/Reuters)Photos (1 of 1)
Key change in accounting may boost banks’ balance sheets
Under the new ‘mark-to-market’ rule, banks can consider the value of assets as if they are being sold in an orderly fashion, not in a distress sale.
By Ron Scherer | Staff writer/ April 2, 2009 edition
Reporter Ron Scherer talks with CSMonitor.com’s Pat Murphy about the revised 'mark-to-market' accounting requirement.
Reporter Ron Scherer
New York
For months, America’s financial system has been buffeted by uncertainty over the value of banks’ assets, which are generally written down to whatever the markets say they are worth – even if they are barely traded since no one wants to own them.
On Thursday, the group that makes the nation’s accounting rules announced it is modifying this key provision, termed mark-to-market. It will now allow banks to consider the value of assets as if they are being sold in an orderly fashion, not in a distress sale.
This modification by the Financial Accounting Standards Board (FASB) is likely to have wide ramifications. With one accounting rule change, the banks’ balance sheets may look stronger. Possibly, the huge injection of taxpayer money for the banks may seem less risky. However, some investor groups warned that the rule change may make it harder for banks to attract capital in the future, if the value of the banks’ portfolios is viewed as subjective. And some are saying that the change must not be viewed negatively by the public.
“It’s important the American people believe this is just not an artificial change in policy that will cover up some asset that should be shown in some other way,” says Donald Powell, a former chairman of the Federal Deposit Insurance Corp., which insures bank deposits. “I want the American people to believe in the banking industry.”
The FASB action is in response to a congressional demand issued at a hearing last month to modify the mark-to-market rules – or risk Congress becoming involved. This has prompted some concern that FASB is setting accounting rules in response to political pressure.
The timing of the change is important. The US Treasury recently announced it will try to put together a public-private partnership to take up to $1 trillion in bad assets off the banks’ books. “This could make the auctions more successful” for the banks, says Bob Brusca, an economist at Fact & Opinion Economics in New York. “Now, the banks have a chance to get these assets off their books at a better price.”
Also, the Federal Reserve is completing stress tests of the banks to determine if they will need additional capital if the economy goes into a deeper slide.
The financial services industry says it’s not entirely happy with the FASB change. Last month, the industry thought that FASB would give it more flexibility to set up proper valuation, says Irving Daniels, a vice president for banking and securities at the Financial Services Roundtable, a lobbying group that represents the industry in Washington. “It looks like FASB has regressed on how to properly value assets now, and that’s hugely critical. It’s hard to determine now what is what.”
But some Wall Street analysts thought the change would benefit the financial firms. “Companies can therefore exercise significant judgement around asset values for many securities in current market conditions, which could significantly boost reported results for banks,” wrote Julia Coronado, an analyst at Barclays Capital in New York. “The new rules are in effect for [the second quarter of 2009] but may be applied retroactively to [the first quarter of 2009], results for which will begin to be released in two weeks.”
How to price depressed loans and securities has been a hot topic during recent congressional hearings. At a March 12 hearing before the Senate Budget Committee, Treasury Secretary Timothy Geithner expressed reservations about some of the proposed changes. “My personal view is we have to be very careful not to do things that would erode confidence in the people’s ability to assess the risks in exposure to a bank,” he stated. “There are some versions of those proposals that would have that risk.”
Federal Reserve Chairman Ben Bernanke, in a Feb. 25 hearing before the House Financial Services Committee, called the mark-to-market issue “a very difficult question.” In principle, he said, it is good for firms to be valued as accurately as possible. “You know it’s good for investor confidence that they think they’re seeing the true value of the underlying … firm,” he said.
But, he added, “it is absolutely the case that under certain circumstances, when you have markets where the asset is not traded or is very thinly traded, it’s very difficult to use market information to judge what the appropriate value is. And that makes the mark-to-market approach very difficult to execute in a sensible way.”
On Thursday, the stock market, which had been anticipating the change, reacted in a very positive fashion. As of about 2:30 p.m. Thursday, the Dow Jones Industrial Average was up almost 290 points. The FASB decision was one factor in the market rally, says Scott Brown, chief economist at Raymond James & Associates in St. Petersburg, Fla. “But the FASB news had been rumored for a while,” he notes.
Although the stock market reacted well to the announcement, some investors expressed some skepticism.
“My thought is that rigging the scale does not mean you have lost weight,” says Doug Roberts, director of research at Channel Capital Research in Shrewsbury, N.J. “This is kind of a temporary fix, but you still have to know what these things [the illiquid assets] are worth.”
Even though one of the results of the move may be to bolster the balance sheets of the banks, the change could make the banks look less attractive as investments, some analysts argue.
“If we water down financial America’s accounting rules so we no longer have balance sheets we can believe in, if we water down the accounting rules to let companies declare the values they want, what does that do to investor confidence?” asks Espen Robak, president of Pluris Valuation Advisors, a New York company that values illiquid assets. “You will want to know what it is they are not telling you, and that will make you much more cautious about buying stocks.”
The Chartered Financial Analyst Institute (CFA), in a letter to FASB, was even more blunt. The move, it said, means “the capital markets will remain closed to major banks and other financial intermediaries for an extended period of time and a higher cost of capital imposed.” It continued, “Investors will not be willing to commit capital to firms that hide the economic value of their assets and liabilities. Reduced capital access will restrict the ability of the banks to diversify their funding sources and slow the recovery process.”
At its press conference, FASB said it valued the input from the CFA. But Robert Herz, FASB chairman, said it reached out to many groups, including mutual funds, hedge funds, and the rating agencies, “and the majority supported what we were doing.”
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Comments
2. Ernest B Crisologo | 04.02.09
It is important to know the true balance sheet of a company, and the true networth of someone that you are helping to retire. I am a financial advisor. That is my job. On a global barket, it is also more important to provide the banks a more stable way of handling the increasing inventories of failed mortgage for temporary reasons. This will allow them to unwind the fuge failures they got themselves into. Failure in the housing market will casue additional erosions in home prices, causing more potentials foreclosures for those who sits on the fence. We now know that homes in potential foreclosures numbers climbed to 5.4 millions and could show up in the bank’s balance sheet as foreclosed assets soon. That could translate to more public hopelessness, and a very long down housing market. As far as Wall Street, it is pretty resilient and will continue to march in a different direction leaving the housing and the banking sectors behind for a while, letting it unwind and to fix its self like it should. The wallstreet investors, did similarly to the tech stocks 8-9 years ago. Capitalist will find a sureway to win. America will continue reign. Ernest
3. Ted | 04.02.09
Just what does it mean that the FASB is responding to “political pressure”? The FASB makes political decisions with extremely important implications for our whole economy. By that I mean public policy decisions. Indeed, public policy for the economy of the world. It is just plain wrong for a private group to feel free to make such important decisions which affect the public. It is like asking Blackwater to make decisions about whether we should go to war, or some fraternal organization to decide how much the budget deficit of the National Government should be. Those organizations that make important public policy decisions should be public and subject to the command of our elected representatives. Hooray for FASB that it has responded to “political pressure.”
4. JimC | 04.03.09
All I want to know is, can I use this “new math” in my checkbook too?
If my end of the month balance comes up short, can I simply tell everyone that 2+2 no longer equals 4 - it now equals 5 thereby adjusting my balance?
What next? Do we get to change the laws of physics?
5. Simplicio T. Soriao | 04.03.09
Accounting convention recognizes historical cost as primary basis for asset valuation. However, price changes affecting such assets attributed to market conditions require thorough understanding before recognizing these changes in the financial statements. Those market forces that culminated in the astronomical rise in real estate values resulted, while inflationary, in fixed assets being recorded still at historical cost because buyers acquired them in a fair exchange that is arms-length, fully disclosed, and with both buyer and seller being unrelated. However, businesses did not anticipate the unusual downturn in real estate values that created those watered assets or those assets whose costs have become unrealistic given present market conditions.
The accounting for investments and equities paints a lucid picture as to how marketable securities like stocks should be afforded accounting treatment. Acquired at cost, owners of stocks do not necessarily recognize unrealized gains attributed to favorable market changes. Rather, they take the opposite approach of recognizing potential losses on investments if sustained losses are severe and prolonged other than temporary.
Real state ownerships are no different especially if owners treat them as typical investments, which they intend to dispose of as a normal economic activity. While this comment may be hindsight, owners or their financial advisors should have realized the pervasiveness or the acuity of those negative changes in property values. Allowance for potential losses attributed to extraordiany economic events should have been recognized earlier to achieve fair market valuation.
It makes me wonder with consternation as to what trend analyses are really for. The succession of economic events that just transpired are not sudden spikes or aberrations, if you will. They are trends and continuing as I write.
Should the prestigious Association of American Institute of Certified Public Accoutants promulgate radical changes in the way toxic assets should be handled? Not necessarily. But it behooves members of the AICPA to revisit those discussions associated with historical cost, appraisal values, conservatism, and liquidity issues because all these topics converge into the ability of a company to sustain itself as a “going concern.”
Simplicio T. Soriao, Jr.
Certified Internal Auditor
Member, Institute of Certified Internal Auditors
USA
6. Adam G | 04.03.09
Smoke and Mirrors…this is why I trade using charts for they don’t lie. The idea of companies determining the values does disgust me.
7. Shirley Freeman | 04.07.09
Well, last month did show an increase in sales of existing homes. If these assets are beginning to move, it does seem time for more flexibility in setting asset values–in the opinion of this ‘economic illiterate’.
8. Robert E. Long, CFA | 04.11.09
It is encouraging to see democratic processes working wherein congressional representatives, responding to real problems in Main Street, strongly “encouraged” regulators to recognize the wealth destruction resulting from “mark to market” accounting regulations. Mark to market requirements, while appropriate in most instances where arms length trading takes place, cannot increase transparency if mo market exists. Modification of rules to permit valuation methodology that has been accepted by courts and market participants over the years for valuing private or tninly traded assets should be acceptable to all parties. Thus, FASB has achieved transparency without wealth destruction. Congratulations
9. Beano | 04.14.09
Some investors are stupid and will buy anything. Some investors are smart and know when to sell to the stupid investors. Changing MTM rules is a God-Send to the smart investors.
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1. Michaela Stephens | 04.02.09
“Investors will not be willing to commit capital to firms that hide the economic value of their assets and liabilities.”
I quite agree. Would I want to commit capital to firms that hide the economic value of their assets and liabilities? No! The main problem this change in accounting creates is that when you have assets whose values have dropped so low that they become a liability instead, if the bank can inflate that value up to where they would like it to be (which could be ANYWHERE and not just what might be reasonable), you have no way of having any accurate idea of the value of your investment. There’s just no way to know. Assets whose values have dropped because their toxicity and risk is apparent should NOT have the same value as if they were safe.
Investors should flee obscurity whenever possible.