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Wednesday, March 04, 2009

 

mark-to-market stalemate


minyan peter on the accounting controversy.

With the consolidation of banks and brokerages -- and, more importantly, the advent of securitization -- more and more loans and other financial assets were transformed into "securities."

Financial firms argued that, since they intended to sell and trade these new kinds of securities, the securities should enjoy the marked-to-market accounting treatment. And the fact that firms did not need to hold reserves on all these securities only made firms argue louder for the highly capital efficient treatment.

The result, not surprisingly, was a huge increase in not just the percentage of assets marked-to-market, but an increase in the overall size of balance sheets, as well.

Now the accounting industry feels like they were taken for patsies - especially when firms stepped up and guaranteed the debt of "off-balance sheet" SPVs. Liquidity was a mirage, and the intention to sell was suspect at best.

And if you look at the rush of firms moving assets (particularly instruments like Fannie (FNM) and Freddie (FRE) preferreds) out of marked-to-market accounting into held-to-maturity hoping to outlast the storm, you can see why the accountants might be more than a little peeved.

My sense is that the accounting industry is telling the banking regulators and the SEC that it's fine if the government wants to suspend marked-to-market accounting - but firms had better set up adequate reserves for the entire remaining life of these heretofore-marked securities and loans, and be prepared to add to those reserves if the economy worsens. Otherwise, the accountants won't sign clean audit opinions.

And this is where the rubber meets the road. The regulators know the assets (particularly the funky tranches of CDOs, CLOs, etc.) aren't adequately reserved for tough times (if they were, would you really need to stress-test the banks?).

So the stand-off continues. And unless the government is prepared to hold accounting firms blameless from lawsuits, I think the stand-off is likely to continue indefinitely.


"holding accounting firms blameless for lawsuits" more or less means that suspending mark-to-market for the banks will result in the financial statements not accurately reflect the probability of default, misleading investors and creating false representation issues, as the banks would effectively be granted a hidden allowance to reduce capital ratios. that's likely just the opposite direction of where banking is actually headed.


UPDATE: via barry ritholtz, jim chanos on mark-to-market. important to note that the vast majority of banking system assets are not and have never been required ot be marked to market. FASB 157 pertain to securitization and derivative issues only.

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GM:
Some day I would like to see my fellow CPAs tell the: Fed, SEC, OCC and Treasury "go to hell. We will no longer stand by while you encourage banks to cook their books". And pigs will fly.

 
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lol, ia. somehow i imagine the requisite forebearance wouldn't be so tough to engineer, given the extent to which the rules are being bent anyway.

 
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sorry -- 'forbearance'.

 
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GM:
Bent? The rules have been twisted into a moebius strip.

 
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