Bloomberg on Papering Over Banks’ Losses

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Bloomberg reports that the proposed changes to mark-to-market accounting rules could boost paper profits at banks by 20 percent.

Hey, if your business sucks, rewrite the accounting rules et voila! “Profit” magically appears.

Mark-to-market forces banks to “mark” the value of their assets on their books quarterly to what they are currently worth in the market. This would seem like a no-brainer, right? If you bought a widget-manufacturer worth $100 million and its stock market valuation declined to $50 million, you write its value down on your books to $50 million—and take a $50 million writedown that’s a one-time hit to profits. The flipside of this is that when asset prices go up, you get to write values up and chalk up one-time gains.

It’s funny, you never heard much complaining about mark-to-market when prices were increasing.

The problem that’s arisen is what happens when there’s no market. That’s part of the problem with the complex securities that the banks underwrote and that are weighing them down—they’re illiquid, meaning they don’t trade much. Since the crash, few have traded at all, so there’s no real price to mark to.

The banks say this is why they shouldn’t have to mark-to-market. After all, they say, they’re not trying to sell these things now, so why should they have to mark them down. They say they want to hold them to maturity and the underlying cashflows imply a value much higher than what the marks would suggest.

Which brings back around to my oft-repeated point that we need to know more about what exactly is on the books. What loans are in these securities? How much cash are they throwing off? I’ve yet to see anyone take a real good look at that. I’m waiting.

Until we know that, we won’t know whether the banks are full of it or not (though you can probably guess what I suspect). The reason there is no market to mark to is because the banks don’t want to sell their assets at prices investors will pay. That’s because if they do, they’ll likely be exposed as insolvent.

So rewriting the rules to paper this over is foolish and counterproductive. Investors need more transparency, not less.

Is this transparency?

The changes proposed on March 16 to fair-value, also known as mark-to-market accounting, would allow companies to use “significant judgment” in valuing assets and reduce the amount of writedowns they must take on so-called impaired investments, including mortgage-backed securities. A final vote on the resolutions, which would apply to first-quarter financial statements, is scheduled for April 2.

I thought by now we were all past the belief that banks had anything approaching “significant judgment.”

Bloomberg is good to point out the massive lobbying pressure on FASB, the accounting-rules board:

FASB’s acquiescence followed lobbying efforts by the U.S. Chamber of Commerce, the American Bankers Association and companies ranging from Bank of New York Mellon Corp., the world’s largest custodian of financial assets, to community lender Brentwood Bank in Pennsylvania. Former regulators and accounting analysts say the new rules would hurt investors who need more transparency, not less, in financial statements.

Officials at Norwalk, Connecticut-based FASB were under “tremendous pressure” and “more or less eviscerated mark-to- market accounting,” said Robert Willens, a former managing director at Lehman Brothers Holdings Inc. who runs his own tax and accounting advisory firm in New York. “I’d say there was a pretty close cause and effect”…

“What disturbs me most about the FASB action is they appear to be bowing to outrageous threats from members of Congress who are beholden to corporate supporters,” said Levitt, now a senior adviser at buyout firm Carlyle Group and a board member at Bloomberg LP, the parent of Bloomberg News.

Spoken without irony by Carlyle employee Levitt, I’m sure.

What Bloomberg doesn’t point out, and what it should have, is that FASB is a private entity. It’s not a government regulator. That’s too much power for an unaccountable group to have.

But this is very good context:

While helping lenders report higher earnings, FASB’s changes may hurt Treasury Secretary Timothy Geithner’s plan to remove distressed assets from bank balance sheets, Dietrich said. Allowing companies to hold on to assets without writing them down could discourage them from selling the securities, which would work against Treasury’s objective to resuscitate markets, he said.

“It’s one of the unintended consequences of having the FASB bow to political pressure,” Dietrich said.

I’d love to be wrong and find out that this whole crisis was just a big misunderstanding—a panic that will reverse itself with a few bean-counter adjustments. It just seems to me that we’re heading in the Japanese direction—delaying the day of reckoning as long as we can instead of getting on with it.

Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR’s business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu. Follow him on Twitter at @ryanchittum.