September 30th, 2008

Minyanville chat:
Feds may can mark-to-market accounting — Better idea:
PRICE CONTROLS

Posted in Money, These United States by ed

Ed Note:  See comments below to follow this notion through time.  As President Obama takes office the stock markets are again in free fall — and again everybody’s talking about “suspending mark to market” to stop the writedown madness.  

“Suspending” alone is not the answer, and alone would lead to a new and even more anarchic chaos.   Price controls are the other side of the coin.

I.e., yes, we should replace Federal Accounting Statement 157 — the 2007 regulation issued by the Federal Accounting Standards Board requiring assets that never supported secondary market trading to be marked on bank books at (non existent) market prices. 

But instead of allowing individual banks to go back to their own pricing models — as the FASB kinda did on the sly with the issuance of Staff Position 157-3 not long after the bankruptcy of Lehman froze the world — the feds should themselves do the modeling/forecasting.

That is, instead of spending hundreds of billions on Band-Aid bank bailouts, hire several rooms of earnest spreadsheeters and have these folks prescribe the “marks” for wounded segments of the structured finance universe, quarter by quarter, based on actual performance and best guesses about the near term future of the relevant industry (eg US housing, for mortgage bonds).  

All as eblaborated at some length here since August 2007, when it was already clear that otherwise the sudden crisis of confidence in the bankers/rating agency models would burn down Wall Street and the City of London. And Frankfurt. And Singapore, Hong Hong, Shanghai and Tokyo.  And San Franciso. Houston.  Charlotte …
———

Here’s a colloquoy I had with a fellow at Minyanville today about price controls.

Background: The Dow 30 rallied 485 today (ho hum) chiefly on rumors the SEC will repeal “mark to market” accounting rules, which would allow institutions to “mark” on their balance sheets their wounded mortgage bonds and similar at prices well above current (non existent) market values — thus, writing UP some of the horrendous writedowns of the past year, juicing the bank balance sheets at a stroke of a pen.

The rumor sparked many alarmed and/or sarcastic reactions from the pundits, money managers and traders I follow.

I responded to one such at Mville. Colloquoy ensued.

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14 comments

  1. ed says:

    Holy cow!

    Some rumor mills are suggesting that the SEC move may not be simple laxation of the m-t-m rules but …

    PRICE CONTROLS !!!

    By a different name, of course.

    “Bank regulators” are rumored to be the ones who would specify prices based on “performance.”

    I staked my claim here in August 2007 and, of course, a hundred times since.

    Late in the afternoon both the SEC and FASB (Financial Accounting Standards Board) issued loose language about changes coming as soon as tomorrow.  From Reuters:
    QUOTE

    In the new guidance, first reported by Reuters, the U.S. Securities and Exchange Commission reminded financial services firms that they don’t need to use fire sale prices when evaluating their hard to price assets.

    “This is a significant first step and adds stability, confidence, and liquidity within the capital markets,” said Steve Bartlett, president and chief executive of The Financial Services Roundtable.

    “By clarifying how to treat assets in an uncertain market, the SEC is continuing to provide transparency to investors and helping institutions to provide credit in periods of market stress.”

    [[Ed:  CLEAR AS MUD! ]]

    U.S. accounting rule maker, the Financial Accounting Standards Board said on its Web site on Tuesday that it would change the agenda for its Wednesday meeting to focus on fair value accounting.

    The board is contemplating issuing additional guidance through a FASB staff position as soon as Wednesday, according to a person familiar with the matter.

    END QUOTE

    Well. We shall see what the morrow brings.

    September 30th, 2008 at 10:41 pm

  2. Babur says:

    Well, I’m just a layman who drops in here to learn a thing or two, but I think I can recognize sweet vindication when I see it!

    October 1st, 2008 at 5:27 am

  3. ed says:

    Here is Floyd Norris of the Times reporting the behind the scene pressures on the SEC re these accounting regulations.

    Norris thinks the accounting rules should stay and that a cure of the same problem is to give the banks a lot of money.

    I of course think — as part of a multifarious package — that price controls would be better than lifting the accounting rules and simply giving the banks unfettered money.

    October 3rd, 2008 at 12:14 am

  4. ed says:

    Here is real estate mogul Sam Zell, who sold a ton circa 2005, talking on CNBC about the inanity of mark-to-market accounting for complex structured finance instruments:

    “Massive impact. Massive impact. Only in the last few months have we actually seen stories about it….I was on your program a year ago and talked about the tyranny of marks, and nothing dramatic has improved. Even the bailout bill has kind of wishy-washy language about trying to reduce the impact of marks….If a mortgage backed security is trading at 20 and the value of it is 50, that’s a thirty percent hit. No system can absorb it. The idea of marking all of your assets to fire-sale pricing just challenges credibility.

    October 8th, 2008 at 5:42 pm

  5. ed says:

    Well, the week of worldwide wreckage has concluded.

    People are now talking about: the feds guaranteeing all deposits everywhere …

    … and simply cancelling all credit default swaps that do not have the subject security warehoused …

    … while the UK finance minister demands action of the G7, not words, or else the world system fails.

    In other words: we are now in a world, ideologically, where price controls on mortagage bonds seems a rather quaint old fashioned idea.

    October 11th, 2008 at 1:19 am

  6. ed says:

    A month later and things are worse.

    The Dow closed below 8000 today, breaking support that had been trying to establish itself.

    People are again, just this week, talking about “suspending mark-to-market accounting” for these trillions of dollars-worth of s-f bonds that were never really intended to trade efficiently enough to achieve “price discovery.”

    To repeat myself (going back to August 2007): price controls on same is the solution. Simply suspending m-t-m will replace Phantom Market Values with Managed Values (set by mgmt of the various instituitons according to their in-house spreadsheet “models”. This would be no improvement.

    Better to level and make transparent the playing field — and stop the writedown madness.  Price controls would do all these things.

    Here is a comment today by Jeff Miller at TheStreet.com.   He’s ALMOST there:

    QUOTE

    CNBC just had a segment with several of their own people, whom we hear all of the time, and Jim Paulsen, the Chief Investment Strategist at Wells Capital Management. The CNBC folks took turns arguing with Paulsen and even offering him a lesson or two. Too bad. Viewers would have benefited from hearing more of what he had to say.

    While he did not use my term, “death spiral”, he made it clear that the problem in financial companies is that we are chasing a moving target. They cannot reduce leverage with the new government capital when we keep writing down their existing assets. They also cannot use TARP money for lending under these circumstances. They cannot attract more private capital.

    Paulsen suggested that we might suspend mark-to-market accounting. David Faber insisted that since marked asset prices have fallen, that proves that m2m was correct. Paulsen, before being interrupted yet again, tried to point out that many of these assets were performing just fine, and held by institutions that did not need to sell. The marks were unrealistic (what I call mark-to-bad markets).

    He and others noted the decline in financials since the day Paulson announced that the original “price discovery” aspect of TARP would not be followed. This has merely confirmed the widely-held trader and fund manager suspicion that financial assets are all “toxic” and “worthless”.

    Everyone is entitled to an opinion, but that one is filed under “things people think they know, but really don’t.” BlackRock has reported that the original Bear Assets they are managing for the Fed (remember when that $30 billion was a big number?) are actually performing better than expected. Bill Gross has made similar comments.

    Why has the market failed to generate good pricing here? The purchasers have to be investors with no fear of irrational markdowns — investors like the federal government. This prevents the development of a real market. It is the reason that the original TARP with price discovery could benefit everyone by ending the death spiral.

    Instead, we are turning the government into an investor that will meddle in compensation, lending policy, business decisions about mergers, and whether the execs fly commercial. Instead, we should be creating the right incentives to let the market work. I am continually astounded that so many who swear allegiance to markets have so little understanding of how they work, the causes of market failure, etc. Sometimes taking a course or two does make a difference.

    Democrats are focused on helping people facing foreclosure. That is nice, but we should be restoring a normal mortgage market so that qualified and eager buyers can find loans. Only then will we have normal trading in those markets.

    I’ll leave the predictions of the trading bottom to those with technical methods. I will make this prediction. We will not see a real solution for financial companies until we do something that directly addresses troubled assets. Here are some dates to watch.

    Since Sec. Paulson is saving powder for Obama, we cannot expect any help from him. The SEC’s study on whether mark-to-market accounting affected bank lending is due on January 2nd. (You can still make comments on their site, and they have another roundtable tomorrow). The new Congress will be in place on January 4th. The new President on January 21st.

    END QUOTE

    November 19th, 2008 at 11:09 pm

  7. ed says:

    Friday and people everywhere are saying “suspension of mark to market” is coming.

    Alone, suspension of mtm makes no sense. With price controls it does.

    November 21st, 2008 at 2:06 pm

  8. ed says:

    Here, the day after Obama’s ascension into heaven, is Vince Farrell, a well known face on the finance tube, calling for the abolishment of mark-to-market accounting regulations.

    It’s worth reading for the discussion of what’s wrong wiht the current accounting, and how it’s burning down the city.

    But I disagree in that i think that MTM should not simply be revoked, but instead should be trumped by price controls for the wounded bonds — fixing one price for all, based on performance, rather than allowing each bank to “model” it’s own portfolio.

    Here is Mr Farrel:

    QUOTE

    First Steps Out of the Woods

    By Vincent Farrell Jr.
    1/21/2009

    Bill Isaacs served as head of the Federal Deposit Insurance Corporation in the early 1980s. The crisis then was Latin American debt weighing on bank balance sheets.

    There always seems to be something troubling banks’ balance sheets. (What is it about our system that requires us to manufacture a crisis every 15 years or so?)

    The Latin debt was trading as low as 10 cents on the dollar, and Isaacs has said that if mark-to-market accounting had been in effect then, the banking system would have been insolvent and out of business.

    But mark-to-mark wasn’t in effect, and the system survived, and most of that debt proved to be worth a lot more than 10 cents. A trade at an abnormal price should not serve as a marker to determine whether an industry survives. The first thing the Obama administration should do is suspend mark-to-market accounting.

    The chaotic leadership in Washington has also undermined confidence in the system. That’s maybe overly critical from a guy who wouldn’t have done any better, but it’s past time for a focused plan that carries beyond the next impulsive idea.

    We first proposed the TARP plan to buy troubled assets. Maybe the powers in office really thought the next better idea to pump capital into the banks was the way to go. Or maybe they didn’t want to tackle how to price the toxic assets. In either case, in went the capital. Out came another measure of confidence, and if a financial system has any bedrock at all, it begins with confidence that the system will be there tomorrow.

    The idea of “ring fencing” bad assets followed, and Citigroup (C) and Bank of America (BAC) have $300 billion and $118 billion of bad stuff set aside with a government backing.

    But since the ring is under the same legal umbrella as all other assets, there is no confidence that they will stay apart. Citi set up an internal “good bank/bad bank,” but it’s internal as well.

    There has been talk about the need to nationalize the banking system like Sweden did during its crisis in the 1990s. Sweden had five banks, and the U.S. has 8,000, so who gets to be the “lucky ones”? That would be a hot debate!

    Before we go too far overboard, I hope the new administration follows through on the idea to establish an “aggregator bank” that will be prepared to buy the bad assets. That way there really would be a “bad” bank separate and legally distinct.

    Until we recognize the situation for what it is and rid the balance sheets of these assets, there will be no return of confidence to the system.

    As I said in yesterday’s letter, this aggregator will have to be funded by the Treasury and will need the ability to issue government-guaranteed debt sufficient to accommodate whatever the appetite might be.

    If and when we do all of this, the healing process is going to take years.

    We will be more a nation of savers than spenders. While that has its merits on a lot of levels, rising loan demand is not likely to occur. It is critical that credit be available, however.

    Profits are the lifeblood of capitalism, but credit availability is a close second. Stability of the banking system should be the first Obama priority.

    END QUOTE

    January 21st, 2009 at 3:34 pm

  9. ed says:

    This week — Week Two under Obama — saw rumors midweek that the feds would go back to the first TARP idea and buy wounded mortgage bonds and the like from the bank.

    Then on Friday word (today) word is put out that Team Obama have run into the same problem there that Paulson faced in October — as discussed in passing here — and that alternatives are again under consideration.

    One middle-of-the-road alternative is replacing mark-to-mkt accnting for these assets with fed-fixed “hold-to-maturity price” (Bernanke’s term).

    January 30th, 2009 at 3:22 pm

  10. ed says:

    Well, the Geithner Plan looks like more of the same, at heart.

    A few people are still talking about suspending mark-to-market — Steve Forbes, for one (a Free Market fundamentalist).

    He has seen the light: there never has been secondary mkts for some of these kinds of s-f bonds, and for others (like credit and mortgage bonds) that DID once have healthy secondary markets, those have been broken since summer 2007.

    Broken markets don’t work. Markets are not fundamental.

    February 8th, 2009 at 2:48 pm

  11. ed says:

    The notion of suspending MTM arose again during the week leading up to Geithner’s speech (today).

    His “plan” (really a collection of ideas — old ideas — that he intends someday to form into policies and programs) is a huge disappointment. He is truly the banks man, and the banks won, shouting down Obama’s central advisors point by point.

    See here — following thru comments — to see what I mean.

    As for dealing with the wounded assets (mortgage bonds, credit-card bonds, CMOs, etc) — Geithner’s idea is to try, as he and Paulson did in late 2007 (the ill fated MLEC for the wounded SIVs), to “encourage the private sector” to buy them, instead of the feds.

    And instead of relieving most of the pressure by replacing MTM with a performance-based model mark program run by the (my old idea) the feds.

    We will now have to wait for Geithner’s MLEC to fail before, again, the rather loud call for suspending FASB 157 again sounds. At which point I again will suggest my “price control regime” (as opposed to allowing individiual institutions to model their own marks).

    February 10th, 2009 at 2:00 pm

  12. ed says:

    Jump to here to follow the MTM debate into the Obamarama.

    March 10th, 2009 at 7:16 pm

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