Marks Revisited

http://www.sec.gov/news/press/2008/2008-234.htm

The above is the new SEC pronouncement on mark-to-market accounting.  Not sure how this will effect the financial crisis, since no one trust anyone’s marks anyway.  However, there will certainly be a tremendous amount of pressure on the Big Four accounting firms to allow banks to “write up” some of their asset backed securities.  If the bailout goes through this could have a significant impact on the price that the Treasury will pay for the assets, to the upside.

A good user-friendly explanation of mark-to-market accounting can be found in the following article:

http://www.forbes.com/home/2008/09/22/treasury-accounting-plan-oped-cx_bw_bs_0923wesburystein.html

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11 Responses to “Marks Revisited”

  1. Steve Grannis Says:

    Here’s another good article on mark-to-market accounting (hope the link works). Warning: the author calls the bailout a “rescue plan,” like San Fran Nan.

    http://voices.washingtonpost.com/livecoverage/2008/09/the_end_of_mark-to-market_acco.html?hpid=topnews

    I think the effect could be to lessen the urgency of the crisis overnight. Sounds to me like Merrill, and others who have already conducted fire sales, should cry foul. There are going to be some real winners and losers when the dust clears.

  2. Mark Grannis Says:

    Dave, I think your link to the SEC Order is broken.

    This seems like a good idea to me, though I do wonder about the ratchet effect, i.e., I doubt anyone is going to cite “other factors” as a reason for not marking to market during periods of “irrational exuberance.” But caveat emptor.

    Don’t miss the comments at the end of the Washington Post column Steve linked to. Talk about a lack of confidence!

  3. Timothy Peach Says:

    Fair value accounting was an enormous mistake, but how do you alter it in the middle of a crisis? Who is going to trust financial reports of banks in this environment? “Oh, we multiplied everything by 1.2, and everything is fine now.”

    Don’t get me wrong — the adjusted methodology would put valuations nearer to the mean of all expected outcomes. It’s not about the “right accounting standard”. It’s about confidence. This WHOLE THING has been about confidence. If we had had any, the banks could have ridden this thing out.

  4. David Fitzgerald Says:

    I fixed the link to the SEC Order in the main post. Tim, you are right to be concerned. Changing the marks now will only make the ability of the Treasury to find a fair price for the assets even more difficult. Paulson was absolutely right when he wanted a clean program passed by Congress. His original proposal was a relatively simple (in concept, not execution) plan to try and induce private capital back into the banking system so that credit would start to flow. Read the WSJ today, Congress is marking up the bill now like its a typical appropriation, every lobbyist getting a piece of the action. The regional banks getting an increase in the FDIC limits, the big banks getting rid of mark-to-market, bankruptcy reform, homeowner relief, forgive me but, a sh*t show!

    I’m disgusted.

  5. David Fitzgerald Says:

    http://dealbook.blogs.nytimes.com/2008/10/01/xstrata-scraps-10-billion-bid-for-lonmin/

    The above is just the tip of the iceberg. Requiring Xstrata to refinance $10 bn within in a year was just a nice way for its bankers to tell them “no way, no how.” The dominoes are starting to fall.

  6. Timothy Peach Says:

    Yeah, I didn’t find out until recently that “force majeure” is French for “get out of Dodge”!

  7. Mark Grannis Says:

    Dave, your dominoes metaphor makes it sound like you think this is a bad thing. To me, it looks like a very concrete illustration of the way easy credit distorts investment throughout the economy, and not just in the mortgage market. Lots of things that look like they’re worth buying when money can be borrowed practically free of charge are not worth doing at competitive rates. Acquiring a competitor is one of those things.

    One prominent pro-bailout argument is that the financial system is too important to the rest of our economy — the lifeblood, or the circulatory system, if you will — to tolerate serious disruption. But precisely to the extent that’s true, isn’t the prevailing interest rate too important an investment signal for us to permit strategic distortions by the Fed?

  8. David Fitzgerald Says:

    Mark, you are, as usual, right. However, Xstrata did not pull its bid because the cost of financing was too high, it pulled it because the banks wouldn’t finance the bid at all, at any price.

    Suppose the $10 bn it was offering was too high for the asset, as almost all bids like this were up until about a year ago. When debt markets are functioning properly the banks will come back and say, we think the business you’re acquiring is only worth $8 bn, that’s all we’ll finance and, btw, our cost of funding is higher than usual so we have to jack up our commitment fees and the spread you need to pay over LIBOR while the loan is outstanding and, as an added kicker, we’re going to have pretty stringent covenants in your loan so that we can keep a close eye on whether your hitting the earnings and cost savings targets you’re selling to us. Xstrata could then either (i) shop the deal to other banks, (ii) go back to Lomin and negotiate a reduction of the purchase price, using the banks’ refusal to fund the full asking price as evidence that Lomin’s shareholders want too much or (iii) reconsider the full costs of its bid to make sure the acquistion will, in the long-term improve corporate earnings. That’s how a functioning market sets a price.

    That’s not what happened today. Xstrata’s bankers told them, essentially, that we won’t bear the long term risk of holding your financing of this acquisition beyond one year AT ANY PRICE. When a bank says that it’s essentially putting up a sign saying we’re closed for business until further notice. If every bank is doing that, that’s truly a distorted market.

  9. Brian Freeman Says:

    Two questions to the financial cognescenti among us re: the “mark to market” standard: The Washington Post column describes it as requiring companies “to set the value for the assets they own at the price they could fetch on the open market right now,” and the new SEC standard as allowing use of “the estimated value [the assets] should bring in the future.”

    1. What valuation timeframe(s) does “mark to market” mean by “right now”? Clearly market value is a moving target.

    2. What valuation timeframe(s) does the new SEC standard mean by “in the future”? There’d seem to be a lot of room for gamesmanship here.

    Also, a comment as to Dave’s post about Xstrata – I’m a little uncomfortable with regarding one (or two or any other particular number) cratered deals, absent a lot of other proof, as necessarily implying dominoes, hyperbolically cascading effects, etc. It’s a crisis, and there are going to be casaulties (with the human toll behind it, in terms of job loss, bankruptcies, etc., being the real casaulties). The dominoes metaphor also would feed too closely into politicians’ proclivity for thinking that the plural of “anecdote” is “data,” and for panic — or opportunistic posturings of panic.

  10. David Fitzgerald Says:

    Brian, the answer to your first two questions is…Yes.

    Under mark-to-market rules, companies have to set their marks when they are required to report earnings. Under stock exchange and other disclosure rules, if ,inter-quarter, a company becomes aware of a deterioration in its balance sheet such that previous earnings guidance that they have given is no longer accurate, they are required to update that disclosure.

    The SEC’s new order, I think, is an attempt to assure banks and auditors that there is no need under mark-to-market rules to value assets at their “current” market price (which is effectively zero today) when the market is so dislocated that it doesn’t reflect anything resembling fair value.

    Does that throw uncertainty into the valuation and auditing process, you bet! I would hate to be a managing partner on an audit account in the next few weeks. That SEC Order is going to be waived around like a get out of jail free card by a lot of corporate treasurers.

    As to your last point, AT&T has to roll its commercial paper on a daily basis and GE just had to basically give away the store to Warren Buffet to secure funding for its financial services business. If AT&T and GE are having trouble getting credit, look out.

  11. Tim Naughton Says:

    Where is Bert Lance when you need him? Now that guy was a creative accountant.


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