September 30, 2008
BUSINESS: Unmarked To Market
An SEC Press Release issued today offers a clarification that may relieve institutions that feel compelled to use "mark to market" or "fair value" accounting for debt securities as to which there is no liquid market (I'll try to just offer a neutral description here; other people at my law firm will no doubt be offering our clients more detailed advice on this topic). This is just one aspect of the credit crisis, but MTM has acted as something of an accelerant for the financial troubles of institutions holding mortgage-backed securities for which there is no active market. Some people, mainly on the Right, have argued that suspending MTM would give needed breathing space and eliminate the need for Treasury to step in as market maker and buy up MBS, while others have argued that loosening the accounting rules just conceals the problem and delays the day of reckoning.
Anyway, today's statement offers at least some clarification that companies need not be rigidly tied in to market prices where there's no market:
When an active market for a security does not exist, the use of management estimates that incorporate current market participant expectations of future cash flows, and include appropriate risk premiums, is acceptable...The determination of fair value often requires significant judgment. In some cases, multiple inputs from different sources may collectively provide the best evidence of fair value.
The statement goes on to note that distressed sales may also not be the best evidence of fair value and deals with other indicia of value such as broker quotes and methods of determining impairment of an asset (recall that unlike, say, the New York Stock Exchange, markets for debt securities do not necessarily have instantaneous public price reporting of all transactions). This is one example of how the regulators are now acting to use the tools already at their disposal rather than wait for Congress to give definitive guidance.
More analysis here.
UPDATE: McCain camp notes they've been pressing this issue since March. Fuller statement excerpt here.
1) New Accounting Methods will only change the way we refer to situations; they will not change the situations. Will this affect whether creditors can squeeze the overextended banks? I imagine it depends on the wording of the credit agreements - and my guess is maybe prospectively, but probably not retroactively.
2) My grandmother knew the price of houses was going to come down. The guy who sells me newspapers in the morning knew the price of houses was going to come down. After all, prices tripled in about a ten year period. If these guys bet the solvency of their firms on housing prices staying strong, why should they not go out of business?
3) I am not in real estate, but 4-5 years ago did anyone else notice that cabdirvers were offering you mortgages? I am not kidding -- a women in my neighborhood ran a nail salon and started offering mortgages on the side. Do you think someone investing billions in these products should have dug into where these morrgages were coming from? and how everyone at the bottom was incentivized to pass along garbage.
3) Before we give the Bush administration another $700 billion, can they account for the $12 Billion in cold cash that went missing in Iraq. Or how about the hundreds of billions that went to fix up the Iraqi infrastructure?
4) I checked on mortgage rates at a few banks today. They're running around 6.25%. That doesn't sound like a terrible crisis to me. What's that you say? People with bad credit or no money down won't be able to get them -- ok, what's the bad part?
I think the reality is that if banks don't have money to lend even for stable businesses (and frankly I like to think of me as among those), then regular business grinds to a halt.
Another thing is credit card use. Credit limits will have to be shrunk, and fewer people will get away with paying only the minimum interest--let's face it, it's a terrible way to function. If banks have no money to lend, then Main Street will suffer twice for the poor behavior of Wall Street (and by that I also mean banks that have nothing to do with Wall Street).
Politically, I can well see why Congress balks. Let's face it, how many regular folks who don't live over their heads and pay all their bills (and hey, I'm one of those, my Mom taught me well), why bail out those morons on Wall Street? So I say what I said before: pass the bill, but any firm that takes the money has to forfeit, without any severance pay, senior management. I mean, they were so stupid and greedy, we don't need them anyway, and it's a real signal. Give the bailout, fire senior staff, and no bonuses for anyone for a period of three years, or until a certain percentage of the bailout, which should really be called an Emergency Relief Loan, is paid back.
Daryl, the bill as structured, as I understand the executive comp provisions, do something like that if the govt is buying beyond a certain threshold from a company.
Meh. This wasn't surprising given the other cover the SEC provided in the form of the short ban. MTM works fine when things are going up, causes problems if you're not expecting it to go down, especially when it might cost you profit if it prepare for it going down. Gotta wonder why they did this - think it's just a response to the talks collapsing?
Mark to Market when it works to you, Mark to Model when it works better. Nothing like flexible accounting standards in order to promote confidence, and making sure investors have all the information.
I wonder how SoX is going to work with getting accountants and CEOs to sign off on this.
I'm not even saying this is a horrible thing - but I much would have rather seen a 4 month relaxation, or at least make assets be reported as "here is MTM, here is our make believe number that we're using mixed Market and Model as we see best."
"So I say what I said before: pass the bill, but any firm that takes the money has to forfeit, without any severance pay, senior management."
Unless it has changed again, as Crank says, this is going to be limited to the top 5 in an institution. You can still pay your star on the energy trading desk or those wonderful Credit Default Swap fellows who have worked so hard. Not so much on dividends and buybacks, or options.
They'll still make nice money. And you can still get that severance pay if your firm is taken over on it's last legs.
Dave, the world isn't perfect. We can't kick all the blackguards out, but if the top people have to go, and nobody gets a vaunted bonus or buyout, then I can be a little more comforted. This bill is the usual: the lesser of two evils. I think I can live with it. I don't think I can live with nothing.
The problem with mark to market is what it does to capital requirements. Easing mark to market is not about cooking the books. It is about allowing the banks to make rational decisions. The stuff is worth more than the last market fire sale price. The bank wants to hold it so that it can get a realistic return. This makes perfect sense.
If capitol requirements (made unrealistic by mark to market), however, force the bank to liquidate or try to add capital, the bank goes under.