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Thursday, April 2, 2009

Mark to Market Augmentation a Good Start

There is a rather peculiar and ironic story on CNBC today.

The potential changes to the mark-to-market accounting rules could hurt the government’s plans to entice private investors into buying toxic assets, but as long as the problems with bank capital are being fixed, it doesn’t matter, Robert McTeer, former president of Dallas Federal Reserve, told CNBC.

“The objective is to stop the destruction of bank capital, it's not to get toxic assets off banks' balance sheets. That's a means to an ends,” McTeer said, adding that there could be numerous ways to achieve the result

It turns out that we didn't actually have to spend $1 trillion in order to resolve the issue of the toxic assets. At the risk of sounding too wonky, the issue of the "toxic assets" was essentially an accounting issue. They were constantly in decline. This created an ever declining asset base on their (the bank's) balance sheets. As such, they had to raise capital elsewhere just to make things equal.

Solving this problem essentially comes down to an accounting issue. This is where mark to market comes in. Mark to market forced these banks to assign current market value to these Mortgage Backed Securities. As such, to solve the issue, what we really needed to do was allow these banks to assign a more long term value to these same assets. Today, FASB did just that.

The independent Financial Accounting Standards Board voted to adopt new guidelines under the so-called mark-to-market accounting rules, which require companies to value assets at prices reflecting current market conditions. The board was meeting at its headquarters in Norwalk, Conn.

The changes will allow the assets to be valued at what they would go for in an "orderly" sale, as opposed to a forced or distressed sale. The new guidelines will apply to the second quarter that began this month.

Now banks will be allowed to give a long term value. Not only will it be higher than a current value but that value won't change each and every day. The other thing this does is render moot Geithner's plan to sell these assets. Now banks don't need to sell them. The tax payers don't need to over pay them. The Treasury doesn't need to bribe private players with great deals to buy them. This accounting problem was solved using accounting and it will now cost the taxpayers about $1 trillion less than it was about to.


Anonymous said...

When I trade stock on margin, if the stock price falls to a level that would wipe out my portion of the investment, even for a nanosecond, the bank can issue me a margin call and wipe out my account, even if it started going back up again 5 seconds later.

If these banks get to suspend mark-to-market than I want that privilege too.

Anonymous said...

The flip side of this is that if the asset's market value continues to decline, the banks can hide it until they need an even bigger bailout.

mike volpe said...

That's assuming they bought these MBS' on margin. You are comparing apples to oranges.

Theirs is an issue of accounting, yours is an issue of finance. You only paid for half the stock or whatever it was, and when it goes down, then you paid for even less. Of course there is a margin call. You only came up with half the money and now it is even less.

These banks, presumably, came up with all the money and the investment is now worth less, though, they have no plans to sell.

mike volpe said...

It's possible they will get even less valuable however over five years, that is very unlikely. While there are a lot of defaults, they are still running at 92% payment. So, most if not all of the yield should be paid. Furthermore, real estate should settle and come back over the next five years so the foreclosed properties would yield enough to cover about what they would be valued for. They are going for 30 cents on the dollar. That is extremely low.

Anonymous said...

I was under the impression these banks were over-leveraged and that was why they are considered insolvent. Or is it because they need to value these assets high enough to offset losses on other assets so their net balance is greater than zero?

mike volpe said...

In reality, what you just said is in a way all true. They are overleveraged but partly that's because they are taking such heavy losses on a lot of the MBS'. So, if the losses aren't made to look as heavy they won't be as under leveraged.

Simon said...

My worry was banks would just "make up" the value of the toxic assets and trust would be eroded.

So the market acted as the independent auditor so to speak. problem is, right now, the market is in a manically depressed mood. This is ok for normal stocks which eventually recover, but its not ok for solvency of banks which form the core of our economy. Like them or hate them, we totally depend on banks.

The value of assets under the new rule will still be certified by an independent auditor. If a loan is performing, then a judgment of its value (based on the cash flow, etc.) will be used to assess its value. Its value is no longer zero if the loan cannot be sold. If a loan is non-performing then there is no option but to write it off. For a portfolio of loans this will get more complicated and may require a “significant” judgment to determine the value right. This is where PPIP comes in as a price discovery mechanism.

This, along with the encouraging signs from the G20 is a good start.

Anonymous said...

This development is a big deal, right? If it is, why isn't it being reported? Maybe the MSM doesn't want to report this because it remove the panic/crisis.

From the beginning of the collapse, mark-to-market was tagged as a major cause. But, nothing was done, until today. And today, the market shot up. Did the mark-to-market (bookkeeping change) contribute to the gain?