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Thread: FASB drops 'Mark to Market' accounting requirement ...

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    Default FASB drops 'Mark to Market' accounting requirement ...

    ... which the stock markets loved ... BUT ...



    (snip)"Let's Play Pretend!
    by Peter Schiff

    When elementary school kids want to escape the confines of their circumstances they pretend to be pirates, princesses, and Jedi knights. Now, with the relaxation of "mark to market" valuation rules announced yesterday by the accounting trade's self-regulatory body, our bankrupt financial institutions can escape their own reality by pretending to be solvent. The unraveling of our fairytale economy over the last few months has not yet convinced us that the time has come to put away childish things. The applause that greeted the news yesterday on Wall Street is a clear sign that we still have some growing up to do.

    The imaginative conceit that lies behind the accounting change is that the toxic assets polluting bank balance sheets are not really toxic at all. They are in fact highly valuable assets that for some irrational reason no one wants to buy.

    Using the "mark to market" accounting method, mortgage-backed securities were valued relative to the latest prices fetched by the sale of similar assets on the open market. Currently, those bonds are being sold at deep discounts to their original value. By "marking" their unsold bonds down to those prices, the insolvency of our financial institutions had been laid bare. The new accounting changes will allow the nervous owners to assign more "appropriate" (i.e. higher) values. Problem solved.

    It is important to note that the Financial Accounting Standards Board made their rule modifications only after intense pressure had been applied by Washington and Wall Street. In their heart of hearts, I can't imagine that there are too many bean counters happy with the outcome.

    The banks and the government have argued that the assets should be valued based solely on current cash flow. Most mortgages, after all, are not delinquent. Therefore, a few bad apples should not spoil the whole cart, and those that are not yet delinquent should be valued at par. This method assumes we have no ability to look into the future and make assumptions about what is likely to happen, which is presumably what the market is already doing by valuing the assets lower than the banks wish.

    All kinds of bonds (corporate, government and municipal, etc.) that are not in default frequently trade at discounts. In fact, the reason that agencies such as Moody's and Standard and Poor's rate bonds is to assess the probability of default. The higher that probability, the lower the value placed on the bonds, regardless of their current cash flow.

    For example, GM bonds that mature 10 years from now currently trade for only 8 to 10 cents on the dollar, despite the fact that GM is current on all interest payments. The 90% discount reflects investor awareness that GM will likely default long before the bonds mature. By the new logic, financial institutions with GM bonds on their balance sheets should be able to ignore the market and value these bonds at par.

    Some argue that the comparison is invalid because GM's bonds are liquid while mortgage-backed securities are not. However, if sellers of GM bonds were holding out for 70 or 80 cents on the dollar, those bonds would be illiquid too. The reason GM bonds are trading is that sellers are realistic.

    The same should apply to bonds backed by mortgages. To assume that a 30-year, $500,000 mortgage on a house that has declined in value to $300,000 has a high probability of remaining current to maturity is ridiculous. The borrower could lose his job, his ARM might reset higher, or he may simply tire of paying an expensive mortgage for a house that is unlikely to be sold at a profit. Any bond investor with half a brain will factor in these probabilities and look for deep discounts. The only way to accurately assess a real present value is to let the market discover the price.

    Despite the pleas from bankers and politicians, mortgages are not plagued by a lack of liquidity but a lack of value. If sellers would be more negotiable, there would be plenty of liquidity. Who knows, at the right price I might even buy a few. The problem is that putting a market price on these assets would render most financial institutions insolvent, which is precisely why they do not want to let that happen.

    Simply pretending that all these mortgages will be repaid does not solve the underlying problems. It may keep some banks alive longer, but when they ultimately do fail, the losses will be that much greater. In the meantime, solvent institutions are deprived of capital as more funds are funneled into insolvent "too big to fail" institutions - hiding their toxic assets behind rosy assumptions and phony marks.

    Going from the sublime to the completely ridiculous, in a speech at the just-concluded G20 summit in London, President Obama urged Americans not to let their fears crimp their spending. It would be unwise, he argued, for Americans to let the fear of job loss, lack of savings, unpaid bills, credit card debt or student loans deter them from making major purchases. According to the president, "we must spend now as an investment for the future." So in this land of imagination (where subprime mortgages are valued at par), instead of saving for the future, we must spend for the future.

    I guess Ben Franklin had it wrong too - apparently a penny spent is a penny earned."(snip)

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    Default Re: FASB drops 'Mark to Market' accounting requirement ...

    slight digression, but I also wonder how much of this is due to institutions aggressively marking up the value of property in line with rises in the market.

    This had the effect of boosting profits, even though nothing had physically changed - it's still the same old building.

    And when property prices went south, hey presto, losses - and yes, it's still the same old building.

    Maybe a rule saying you can only realize any profit on increase in value of a building when you sell that building to an unrelated company... Would have stopped a lot of this.

    Phil.

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    Default Re: FASB drops 'Mark to Market' accounting requirement ...

    Mark to market only works in a liquid market. If noone's trading, or if the last trade was done by someone with lots of market power, who's to say what something's worth? Then you can have some big institution bully the market and drive other people broke via margin calls, if you're marking everything to the last traded price.
    Last edited by person; 04-04-2009 at 06:23 PM. Reason: calrification
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    Default Re: FASB drops 'Mark to Market' accounting requirement ...

    ^^^ as to liquidity, author Peter Schiff already 'hinted' about the answer. Indeed GM bonds would not be 'liquid' if GM bondholders were not forced to sell their holdings at whatever price the market would bear ... i.e. if a government for example had been willing to loan them huge amounts of short term cash at extremely low interest rates so that they could cover other financial obligations without forced bond sales. Stated inside out, where mortgage bonds are concerned, in the absence of gov't bailout money i.e. Lehman Brothers, forced sale of mortgage bonds quickly established a 'liquid' market as well as a market price.

    The problem of course was that the resulting market price was on par with the market price of GM bonds at 'pennies' on the dollar, which if applied to similar mortgage securities would have resulted in technical bankruptcy for every financial institution holding such securities. So as you have indirectly pointed out the government and the banking industry wish to impose a 'value' which is far higher than this market clearing price to avoid technical bankruptcy. The FASB rule change allows them to do so. However, the FASB rule change does not alter the 'true value' of those mortgage securities ... whatever that may be.

    In terms of 'true value', I'm no Black-Scholes scholar. But I do know how to read. At the moment, some 10% of all US mortgages are delinquent. Also at the moment, real estate market prices are down at least 20% meaning that many many homeowners now have negative equity. Also at the moment, some 650,000 Americans are losing their job every month meaning that many many Americans will no longer to afford making next month's mortgage payment while still paying for food and other necessary expenses. As to how these facts can be ignored regarding a future default rate of mortgage backed securities being low enough to sustain their 'book' value can only be explained as the author has already explained it ... 'lets play pretend !'.

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    Default Re: FASB drops 'Mark to Market' accounting requirement ...

    So say you're in an airport and want to exchange USD$500, and the only currency exchange says "We'll buy USD at 0.000001 Sheckles and sell at 100 Sheckles". Should you be forced into bankrupcy because you can sell him your house for 1 Sheckle? What if you're not even at the airport and that's the rate they're quoting?

    Saying what something is "worth" is a bit trickier than chucking it all on the market and seeing what happens, really.
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    Default Re: FASB drops 'Mark to Market' accounting requirement ...

    ^^^ your comment still carries with it an implied third party 'rescue'. Put another way, if Zimbabweans are starving will they pay 1 million Zimbabwe dollars for a loaf of bread ? In the absence of UN food deliveries paid for by a third party, the answer was obviously yes. However if a third party intervenes, then the market is changed - the 'values' are changed etc. But ultimately the third party must pay for this 'temporary' forced change in value. The third party must then either keep intervening forever, or somehow hope and pray that other market forces will cause the 'true' value to increase to a point that equals the 'artificially inflated' value which resulted from their intervention. Thus the FASB rule change will only work as long as the third party (i.e. taxpayers) keeps maintaining the artificially inflated valuation.

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    Default Re: FASB drops 'Mark to Market' accounting requirement ...

    i am sad that FASB's back was put against the wall, and that the spin is such to blame them, when they were not the architects of such idiocy.

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    Default Re: FASB drops 'Mark to Market' accounting requirement ...

    I guess there is more than one way to look at this. Why should you have to keep "marking down" the value of an asset that you own when you have no intention of selling it and certainly not at some bargain basement price because right now that is all the handful of "willing buyers" out there are willing to pay so therefore you are NOT a "willing seller".

    An analogy would be if I bought a house in January of 2007 for a million dollars, IF i had to sell it right now maybe all I could get for it is lets say 500K but I don't want to sell it now and fortunatley for me I don't have to so I hold on to what as far as I am concerned is still my million dollar house. Next year or in 2011 or it will again be a million dollar house.

    In the end a lot of Mortgage bonds will be worth what they are supposed to be due to the fact that most people are still paying there mortgages on time. It is true that no ones wants to pay that now, but they are not really for sale right now either. The banks don't want to take a bath by selling them now for pennies on the dollar so that does not make them "willing sellers" and that is/was supposed to be half of this mark to market equation.

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    Default Re: FASB drops 'Mark to Market' accounting requirement ...

    ^^^ again your example carries with it an implied 'third party' rescue. Banks or individuals are both in a position of being an 'unwilling seller' if the current market price is less than they originally invested. However, 'remaining' an unwilling seller requires that the bank or individual receive third party help to stave off bankruptcy if the property is not to be sold to satisfy existing financial obligations. This basically boils down to cost shifting, from the bank or individual to the third party.

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    Default Re: FASB drops 'Mark to Market' accounting requirement ...

    Mark to Market was just one of the many 'oddities' of accrual accounting.

    One other is assuming sales of items put into the sales inventory -- how stupid!

    Someone notable on the 'McGlothlin Report' said well then let's have "Mark to Fantasy."

    Why not simply mark to book? Is this a case of the monkeys running the zoo?

    And with mortgages have three categories (since things can change monthly) -- performing (current), questionable (say 2-3 months behind), and non-performing (foreclosure or imminent forecosure). and not just lump them incdiscriminately. Re-eveluate monthly; we already have mortgage record computerization, why not just use it? WTH....idiots running the shop?
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    Default Re: FASB drops 'Mark to Market' accounting requirement ...

    Quote Originally Posted by threlayer View Post
    And with mortgages have three categories (since things can change monthly) -- performing (current), questionable (say 2-3 months behind), and non-performing (foreclosure or imminent forecosure). and not just lump them incdiscriminately. Re-eveluate monthly; we already have mortgage record computerization, why not just use it? WTH....idiots running the shop?
    That is exactly how banks who do not sell their mortgages should value them. The problem is banks that sold morgages and bought mortgage derivatives. How to value the derivative? I am not convinced that changing our accounting rules is a good idea. I am not convinced it is a bad idea. What I am convinced of is banks selling mortgages is a very bad idea.

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    Default Re: FASB drops 'Mark to Market' accounting requirement ...

    ^^ Random (and fractional unit) packaging to 'spread the risk' seems not to have worked out very well either.
    I loved going to strip clubs; I actually made some friends there. Now things are different for the clubs and for me. As a result I am not as happy.

    Customers are not entitled to grope, disrespect, or rob strippers. This is their job, not their hobby, and they all need income. Clubs are not just some erotic show for guys to view while drinking.

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    Default Not quite accurate

    FASB doesn't matter here, what matters is what the FDIC, State Regulators, SEC and IRS have to say.

    That said, the source didn't describe the change in guidance accurately, the change in guidance is for inactive securities... making them effectively not Available For Sale. It's still ill advised, but not as dramatic.

    Source: FASB 157

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    Default Re: FASB drops 'Mark to Market' accounting requirement ...

    Mark to market is easy to do with a highly liquid asset. But things are not so clear when there is limited or no liquidity. Here is some news on how IFRS is handling mark to market. The SEC is eventually going to converge with IFRS so it's fairly relevant:

    NEW YORK, March 4 (Reuters) - The International Accounting Standards Board (IASB), which sets accounting rules for more than 100 countries, said on Wednesday it is altering its mark-to-market accounting rules to bring them more closely in line with U.S. standards.


    The London-based board has amended mark-to-market rules, so that companies using International Financial Reporting Standards (IFRS) will also have to report asset values in a three-level hierarchy, based on the liquidity of the assets.


    Mark-to-market, or fair value accounting, requires companies to measure their assets based on what they could fetch in a current market transaction.


    Under the three-level hierarchy, a Level 1 asset can be marked-to-market based on a simple price quote in an active market. The price of a Level 2 asset is "mark-to-model" and is estimated based on observable market prices and inputs. A Level 3 asset is so illiquid that its value is based entirely on management's best estimate derived from complex mathematical models.


    "The financial crisis has shown that a clear understanding of how entities determine the fair value of financial instruments, particularly when only limited information is available, is crucial to maintaining confidence in the financial markets," IASB Chairman Sir David Tweedie said in a statement.
    Some bankers and investors have blamed fair value accounting rules for exacerbating the financial crisis, saying banks were forced to mark down assets to artificially low prices. Differences between standards used in the United States and overseas have also been a source of contention, amid claims that there was an un-level playing field.


    The IASB's accounting changes are also intended to "clarify and enhance the existing requirements for disclosure of liquidity risk," the IASB said. The board said that additional disclosures would also be required for Level 3 assets.


    The amendment to International Financial Reporting Standards (IFRS) affects a standard known as IFRS 7, and takes effect for annual periods beginning on or after January 1, 2009, the IASB said. (Reporting by Emily Chasan; editing by Richard Chang)

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