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Mark-to-market manipulation
Commentary: Efforts to change accounting rules would set back reform
By David Weidner, MarketWatch
Last Update: 12:01 AM ET Nov 4, 2008
NEW YORK (MarketWatch) -- Mark-to-market -- or fair-value -- accounting has one big problem: Some very powerful people are trying to change it.
A movement spurred by bankers including Aubrey Patterson, chief executive of Bancorpsouth Inc. BXS, and Wall Street power brokers including Blackstone Group BX Chief Stephen Schwarzman are arguing for at least a temporary suspension of Financial Accounting Standards Rule 157.
Patterson and other supporters argued for the rule's suspension in a Securities and Exchange Commission roundtable Oct. 29. Other critics of FAS 157 included Damon Silvers, AFL-CIO general counsel, and Bradley Hunkler, an insurance executive from Western & Southern Life.
Simply put, these guys want the government to stop requiring mark-to-market accounting so the financial industry can put blinders on to the deep trouble that lies on its balance sheets. Not surprisingly, the proponents of a suspension would also apparently benefit from it.
For guys like Patterson, it would mean his bank wouldn't have to take big charges each quarter to build reserves. Bancorpsouth increased its reserves by 50% to $16.3 million to gird against loan losses at the end of the third quarter.
For Schwarzman, suspension of the accounting rules might allow banks to start lending willy-nilly again -- and that would mean a return of the cheap financing that fueled the private-equity buyout boom between 2005 and 2007. Private equity now must re-fund many of those deals with new loans or debt extended at much higher interest rates.
'Fair value'
What is FAS 157? It is the rule that has essentially put us in this credit crisis. FAS 157 requires banks to mark securities -- including collateralized debt obligations -- at the going price. In a nutshell, it requires financial firms to value securities on the balance sheet at the price they would fetch in the open market.
All of those write-downs you've been hearing about have come as a result of the demand that banks value securities composed of risky loans at market prices -- which, for a multitude of collateralized debt obligations, means zero.
Proponents of suspending the rule argue that a market price isn't a fair way to value these securities. If a worthless CDO of 1,000 loans is held to maturity, some of those loans will be repaid. In fact, many CDOs are performing with zero or small default rates, but they are deemed worthless because there is no place to trade them in the market. No one wants them.
Ultimately, what the proponents of the rule's suspension are saying is that there are two values, market value and maturity value. They say maturity value is what matters because market value can be tainted by panic.
It's like trying to sell Chinese-made toys that may be coated in lead paint. Sure, people aren't going to buy them because they're afraid they're going to give their kids brain damage. But you know Steve Schwartzman is at Toys "R" Us stocking up. Those are perfectly good toys, he thinks. He doesn't see lead. He sees gold.
The eBay Rule
The accountants instead favor what I like to think of as the eBay Rule. They say a balance sheet needs to be made up of assets that can be converted to cash. There's no better way to find out the value of something than to put it on sale.
Supporters of the rule also point out that FAS 157 isn't as rigid as critics suggest. Indexes, past prices and cash flow from a security all are fair game when determining the security's value. If it was market pricing alone, basically the whole CDO market would be worth a cup of coffee and a share of Blackstone.
The accountants instead favor what I like to think of as the eBay Rule. They say a balance sheet needs to be made up of assets that can be converted to cash. There's no better way to find out the value of something than to put it on sale.
Here's the bottom line: A temporary suspension of FAS 157 would be a return to the fantasy world that created the credit crisis. Banks overvalued toxic, extremely risky, dead-on-arrival securities to begin with. Why would the government allow them to go back that lack of standards?
If these devalued mark-to-market assets are really so valuable -- or will be -- why aren't Patterson, Schwarzman and others out there buying them all up at pennies on the dollar?
Banks made the mistake of creating this junk at a huge profit without looking at that junk's true value down the road. In the end, cash is cash, and good mortgages are good mortgages. One man's gold is garbage in a market that sees it for what it is.
After making so many mistakes in this credit crisis, now the SEC and other regulators are considering eliminating one of the only regulations that has not only withstood an era of deregulation but actually worked.
What the industry and SEC Chairman Christopher Cox should be talking about is a mark-to-market principle on the front end that helps banks avoid bad loans.
That way when the piggies go to market, it won't be whee-whee on the rest of us.
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