Banks Seeking To Value Assets Higher Than Market Value
Banks are pushing for a change to banking rules that would allow them to ignore mark to market accounting for assets in markets that they deem "inactive." In other words, if a bank is loaded with worthless assets but decides that the market for those assets is frozen, they can value those assets higher than the market would. Or to simplify it even more, they can create value out of toxic assets. And it looks like now the Financial Accounting Standards Board, which so far has been against this rule change, is caving in.
The Huffington post points out that this is an abrupt about-face for the FASB:
The move marks a shift for Robert Herz, head of the FASB, who recently told a panel of lawmakers that the harshest critics of mark-to-market accounting practices have been the very same banks that have gone under when regulators would not let them adjust their accounting. Herz and other regulators have been under intense congressional pressure to reform the rules.
"I will tell you that I get calls and visits from some of those institutions that are now in government hands, about two weeks before they get taken over, trying to get the accounting changed," he said. "Clearly some of the most vocal opponents of fair value and mark-to-market have been some of those institutions that ultimately failed and have had to have billions of taxpayer dollars put into them."
If you're interested in having a say on this issue, read the full article at Huffington Post and check out the info below.
The public is entitled to comment on the rule change until April first. Comments can be e-mailed to director@fasb.org — File Reference: Proposed FSP FAS 157-e. Or send snail-mailed Technical Director, FASB, 401 Merritt 7, PO Box 5116, Norwalk, CT 06856-5116, File Reference: Proposed FSP FAS 157-e.
"New Rule Would Allow Banks To Choose Values Of Their Assets" [Huffington Post] (Thanks to Marge!)
(Photo: The Sierra Club)
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Comments:
Heard a great mark to market discussion last week. Everyone was fired about about what it would do to their balance sheets when prices were going up but everyone knew it would be just as painful if prices fell.
There is never a demand problem, only a pricing problem. Someone will ultimatly buy an asset if priced right. The problem here is the banks don't like the prices being offered.
Did they see the last South Park about the 97 trillion dollar valued Margaritaville and come up with an equivalent idea of their own?
This isn't strictly a bad thing. Mark to Market is partially responsible for so much financial trouble. The fact is that when the bank owns a house it is worth something, even if its not a lot its still worth something. So the bank owns all these houses that have been foreclosed on and the banking rules require them to mark those assets as having zero value!
All of the sudden a solvent company becomes insolvent on paper because they are forced to account for assets as having zero value.
On the flip side there is a problem of account for those assets as being worth too much, there is a balance that has to be maintained.
This is a glass half-empty or half-full situation. If you believe that the hype about these assets has damaged their current value but they are still fundamentally sound, then mark-to-market is unfair and short-sighted. If you think these assets will never have any value -- and you're a taxpayer being asked to buy them -- you want that low, low "market" value.
Wall Street isn't making it any easier for us to sympathize, what with the 3-figure lunches and gazillion-dollar bonuses for failure. The best solution right now -- IMHO -- is to pull their butts out of the fire with this Public/Private Partnership and then regulate the financial industry to within an inch of its life so that when the capitalists screw up next time (and there will certainly be a next time) the cleanup won't be as painful.
It doesn't surprise me as the banks have already found a way to game the system by purchasing assets for 30 cents and then selling it to the PPIP for an inflated price. Pocket a quick huge profit with no one being any the wiser.
Yeah, I have $1000.00 in my bank account, but I'd like to pay off that dang credit card, so I'll just pretend my $1000 is worth $10,000, OK?
What could POSSIBLY go wrong?
And we seem to have come full circle, mark-to-market was one of the accounting rules abused by Enron in it's over inflated #'s, now it's the "reason" assets are worthless, irony anyone?
This seems like a very bad idea. First they get into trouble by fictionally eliminating the risks on assets (thereby increasing the value) and now they're trying to fictionally increase the value? I'm not an economist and I warn you that I'm dyslexic with a bit of discalculea, but could someone explain to me how this sort of further accounting shenanigans would be a good idea?
If banks are allowed to determine the value of their assets without regard to current prices, investors have less trust and confidence in the integrity of their books and their assets, which could further freeze markets and further drive down prices.
The proposed FASB rule, according to a release from the agency, "provides a framework for measuring fair value and a definition of fair value that contemplates an orderly transaction between market participants, not a forced or distressed sale."
But isn't a forced or distressed sale more likely than not what's going to happen? Are backs then irate that their artificially inflated security assets are showing a value far less than it had in its inflated state and opposed to a more or less actual valuation of the security because it would cause people to have less confidence in them? How is this not just an attempt to create another bubble?
@PunditGuy: There's a great YouTube video out there showing how the Public/Private Partnership will allow banks to borrow government money to "invest" in their own securities (at full price of course) for pennies on the dollar. Basically, the FED and the American taxpayers are going to end up on the hook for all of the toxic assets.
This makes a lot of sense. Mark-to-market itself implies that there is a market. When there are very few buyers, is that a market? Was it supposed to be "Mark-to-OBO?" It's like saying that my TV cost $500 a year ago and I need to sell it, but since I can only find one homeless guy willing to buy it for $10, is my TV really worth $10?
It gets even better. What if the TV generates cash flow? Shouldn't I get credit for the fact that the asset generates a return? My understanding is that current mark-to-market doesn't reflect that.
This revision is good for consumers - if mark-to-market stays in place today, banks will be forced to sell assets to maintain a capital level they really don't need. Some banks would artificially fail, with FDIC and the taxpayer paying for the pleasure. Mark-to-market is a key driver to the downward spiral we've seen.
If handled properly, this isn't a bad thing. Many of these banks have positive and sustainable cashflows, but the accounting rules force them to account for the dollar value of assets IF THEY SOLD THEM THAT DAY and treat it the same way. But that 's the problem: if the banks aren't selling the house, its because they think they can do better down the line. The rules now are only causing troubled banks' balance sheets to swing even more wildly, exaggerating the effects of the broader market and scaring investors. Obviously, ignoring the value of assets as an indicator of financial health is just as stupid, so some kind of balance needs to be struck. We'll see if the government manages to do just that (I'm not holding my breathe).
@T. Daniel Garfield: Not so fast.
The banks don't own the house, that house still has a value. The banks and other large investors have a tranche of a MBS whose revenue stream has dried up and will never be able to pay off as anticipated due to falling home prices.
Essentially they have a bankrupt security. This is no different than holding bear stock when the company went bankrupt, you took a gamble with an investment and it didn't pay off ( and never will ).
Mark to market (MTM) is a good valuation method when the market is working properly. The problem with the mortgage backed security market right now is that it isn't. FASB doesn't like the idea of deviating away from MTM since it creates a transparency issue, which I understand. However, I don't think this the end of the world.
This isn't the first time FASB has bowed to Congressional pressure. If you want a good case study, look at the history of stock option expensing.
@PunditGuy: If these assets have so much value why doesn't someone with cash ( like buffet or hedge funds ) buy up all of these valuable items? Are the taxpayers really so gullible as to believe that all these other investors are passing, but the assets are really, truly valuable?
That's because they know better.
If this same rationale were adapted to dating, then every man would possess a 16" purple sheathed one-eyed monster.
So they're going to change a big part of GAAP then?
I believe assets are to be valued at fair market value, unless FMV isn't available, then it's book.
I've had this pounded into my head for the past 3 years and now it's about to change. Ergh...
@tankertodd: If "the market" only counts when bubbles are percolating, then something's broken. They had no qualms marking up assets during their ascent; gravity is a cruel mistress.
@snowmoon: Not so fast either. Would you consider it fair to have to mark down assets you planned on holding for a few years due to the economy, which presumably would rise in value when you would want to sell the asset? Of course not, so why should you have to mark it down to the current selling price if you don't plan on selling it currently. This mark to market, enacted on November 15, 2007, is exactly what has exacerbated the crisis, if not initiating it itself!
Mark to market is great when a market truly exists for the security being valued. However, the current economic situation does not provide a valid market for these securities to base their value on. There are different levels of inputs of course, Level 1, Level 2 and Level 3.
Level 1 means that there is an active market for the security and that it can be clearly valued within that market, obviously not the case. Level 2 bases value upon other observable market prices for assets as no direct market exists. Level 3 is when there is no comparable market and the management then has to use professional judgment to determine the value of the assets and any sort of impairment that might exist. This is where the problems start. When you introduce this judgement call, who determines the value of these assets? You bring in the management's opinions on the possible future markets for assets.
This proposal at first blush sounds like it could be a problem and eliminate a level of transparency, but at the same time it is correct in that a lot of these assets do hold some value at least. They haven't been entirely impaired. A house is still worth something if a bank owns it, it just determining how much that's the problem and is why the rules are currently written in such a way to eliminate the asset's value entirely.
@Jesse: I just don't see how it's supposed to help. I thought the reason banks weren't lending to each other was because they didn't know who had real assets and who was on the brink of failure. Doesn't eliminating MTM just further cloud the issue by letting them sweep their bad assets under the rug?
I can't help but think; couldn't the banks have just exercised some control and not flooded the market with the foreclosed homes that they took possession of? Prices plummeted because they themselves engineered a high supply, low demand environment. They might have had to pay some caretaker fees and the like, but couldn't they have just sat on the majority of their new assets and just trickled them onto the market slowly enough not to depress market values?
My understanding of the concept of mark to market is: If a business unit was forced to close their doors today, what could they get for that asset. if there is no market, then i would percieve that to be a worthless asset. It seems like, there is a market, and that asset is priced at $0. if these banks are allowed to give their toxic assets a value, and then are forced to liquidate their assets one day, their balance sheet is essentially useless.
The problem with mark to market in this instance is that there is not market. these assets are still providing revenue and and should have an intrinsic value, but when nobody's buying, everything is technically worthless.
@David Brodbeck: No, the banks aren't lending because they've had to mark the value of so many of their assets to very low values thus making them look insolvent. If they lend out their cash they look even more insolvent which could evnetually lead to a collapse.
@Shane Elliott: the problem is all banks would have to agree to it. if one bank decides to hold onto their inventory for purposes of strenghtening the market they run the risk of being the last guy holding the bag if everything drops in value. even if all banks did decide to do it, it'd probablyu be considered collusion, just like if the oil companies artificially lowered supply to juice up prices.
I love how so many people seem to forget econ 101. The price for an item is determined by supply and demand. No demand? Abundant supply? Your price is going down or nonexistant. Don't like the price being offered? Hold on to your items and wait for that to change. This is how a free market functions. Sellers are not pleased with the low price of their goods and refuse to sell. This decreases supply which in turn will eventually increase the price.
I know your balance sheet holds a large quantity of assets that are no longer valued as much, but is lying about what they are really worth the right thing to do? Just because there is no market for your item doesn't mean you have to liquidate the item to rectify your balance sheet. Perhaps, instead of basing such large swaths of your balance sheet on wildly fluctuating assets in order to leverage yourself 30 times over, you should have relied on something you understood. Things like capital goods, equity, etc. Using an inflated market (dot com stock, houses, etc) for your 'assets' so that you can go out and get into the CDS market that no one understands is a very stupid thing to do. Perhaps, as capitalism dictates, those who act stupidly should be punished. Not allowed to lie about their assets any more.
Makes sense, in a pointless way. If the market is frozen, they could value the assets at anything they wanted. They could value them in imaginary currency at nonsense values, like three-umpteen flogoolian stained-glass Unicron heads.
Okay, realistically, they can value them at what they think is fair, so long as the markets aren't moving. Once they start moving, the valuation becomes meaningless, and everything will revert quickly to mark-to-market rules. More importantly, those assets are frozen so long as their coupled markets are frozen, so any valuation will appear as an obvious blind.
For instance, I own a few faded T-shirts from various company picnics. I could value them at thousands of dollars despite there being very little market for them, but if I try to insure them at that value, the insurance company would probably get a little giggle out of it.
@JGKojak: Its more like:
My house is worth 200k and still nobody wants to buy it. However now that i estimate it at 10mil, I'd like to take out a home equity loan on that amount.
Here's an idea: Have the executives of these banks back up the higher prices with their own money. If an asset has a market value of say $100,000 and they want to value it at $200,000, if the asset ends up being worth closer to $100K, have the executive pay the difference to the bank out of his own pocket. By making people RESPONSIBLE (hey, what a new concept!) for their mistakes, we'll likely see a lot more care involved in valuing these assets.
@tankertodd: Will banks then take crappy personal items of mine as collateral because of sentimental value?
Better yet, are they willing to buy more securities at this value?
@Trai_Dep: I think you misunderstand. They would all still be tiny, but we could take a PELOC on them as though they were 16"-32".
@zonk7ate9: But lending against assets in a frozen market? That's highly irresponsible. Once the markets are moving again, the higher valuation becomes meaningless. Mark-to-market isn't just an accounting rule, it's a cog in the machine; it will adjust the asset value if the market picks up again. If the market picks up again, these banks will seem insolvent all of a sudden, and with no contingency to deleverage in time. It's short-sighted to assume that the market will do anything but turn around eventually (maybe decades from now, but eventually), but the price may take even longer to rise, if it ever does.
In short, this is a fool's bet that the status quo will be maintained long enough for the banks to do whatever it is they're planning. From experience, we can guess they're drafting up "cut and run" plans right now.
Actually, artificially raising the paper value of an asset sounds suspiciously like what started the snowball rolling down the hill in the first place.
Here's the problem with the current mark-to-market rules.
Let's say that you want to sell your house. OK, not the best time, but comps in your area are still a few points above what you paid, and you have lots of equity, so you're good.
You put your house on the market. You expect it to take about 6 months to sell, which is fine with you.
Month number one, nobody makes any offers on your house.
Well, according to the current mark-to-market rules, congratulations! Your house is now worth zero. Take it off the market, because it's worthless. You have no bids, thus your mark-to-market value is zero.
Artificially inflating values may not seem like such a great idea, but lets not forget that these "toxic" assets have underlying intrinsic value that will recover someday.
@Trai_Dep: If this situation was applied to dating, the taxpayer would be footing the bill for the prostitutes to say you had a 16" purple sheathed one-eyed monster.
@chrisjames: it would actually matter if they overvalued the assets during the frozen market. The reason? Government bailouts. If they can freely fiddle with market values however they want, then it will be us that pays the imaginary prices to buy up those assets.
Yay! People are getting to the point they can spend money again, AND the government is kicking in to first time home buyers, AND they just publically smacked us in the mouth so we can get away wtih things again... What should we do? I KNOW! We can take all this crap property no one wants to buy, swap the stickers, wait for the initial wave of buyers, and BOOYAH! Six months later, no one knows any better and we have a bunch of people ignorant to our ASSinine, convuluted processes and policies scrambling to get into any "deal" they can while STILL trusting us to actually help them despite centuries of trying to control the world.
Certainly does make flipping a house easier when you don't have to do anything to it and it skyrockets in value anyway. This is one of those things where it has come so full circle you almost think Capital One/BoA/whoever did it on purpose. Are they EVER going to stop trying to ram it into us? We have literally GIVEN THEM MONEY at this point and yet they are STILL doing what they can to make sure they score the extra buck off our backs.
I am so sick and tired of the way modern society perpetuates this sort of stupidity on a massive scale. This is no different than their overdraft fees, "free" checking accounts, or any of the other crap they try to pull while we pay for the priviledge of letting them trade our money to make EVEN MORE cash. And we put up with it!
It's seriously driving me to nationalization, which I thought is something I would never approve of. Maybe banks need to become a utility, at least until they figure out how to be accountable to their "customers". I understand that banks are just another business, but this is stupid. These are the people that run THE most powerful force in the world: cash! These banks might as well be opposing governments with how they act and try to influence the lives of other people. All they need is an army or police force and they're set.
Currently under FAS 115 an asset would not be revalued only if the owner demonstrates positive intent to hold the investment to maturity.
From the press release:
Market-related losses would be recorded in other comprehensive income if it is not likely that the investor will have to sell the security prior to recovery.
This means that that equity would be lowered by a change in unrealized losses. How to do this without lowering the asset value is a mystery to me. The credit half of the entry has to be posted somewhere.
FASB has other rules that are meant to shield the statements from extreme volatility. The most important regards the treatment of reporting for foreign subsidiaries whose local currency is hyper inflationary. FASB allows you to carry their balances in USD.
Watching so many arm chair economics flail about is amusing.
Any really Consumerist, using the Huffington Post? Can you make your bias anymore hysterically obvious?
@chrisjames: If Im wrong on this please correct me, but, isn't the value of anything determined by what someone's willing to give you for it? So yes your tv is only worth 10 dollars.
Sweet. I'm assuming this will apply to me too. Right?
It will be great telling everyone how I'm now worth a billion dollars with my busted screwdriver collection. The market for those is inactive but I'm pretty sure they're worth $100 million each.
Gil