House bill would create panel to OK accounting rules

Get ready for another push to suspend "mark-to-market" accounting rules.

A bill introduced late Thursday by Rep. Ed Perlmutter (D-Colo.) and Rep. Frank Lucas (R-Okla.) would create a federal board to review the "application" of accounting principles -- including controversial mark-to-market rules.

The new board would oversee decisions of the Financial Accounting Standards Board, the independent body that dictates accounting standards.

The new federal board's members would be the heads of the Securities and Exchange Commission, the Federal Reserve, the Treasury Department, the Federal Deposit Insurance Corp. and the Public Company Accounting Oversight Board.

The panel, taking authority the SEC now has, would "give discretion to the regulators to consider the overall condition of the financial market," Leslie Oliver, a spokeswoman for Perlmutter, told Bloomberg News.

The FASB, which now sets accounting rules under SEC supervision, takes a "narrower approach," she said.

The banking industry has asserted that mark-to-market, or fair-value, accounting has worsened the financial crisis. The FASB's rules require financial institutions to value securities on their books at current market prices, even if the securities don't mature for many years.

Bankers say that has unfairly ravaged their balance sheets because, they say, market values of mortgage-related securities have been unrealistically depressed, reflecting the massive uncertainty over the housing market.

"As we work to stabilize financial markets and rebuild the economy, we must look closely at the regulatory structure to see what is helping and what is making things worse,” Perlmutter said in a statement.

The banking industry didn’t hide its enthusiasm for the new oversight regime that Perlmutter and Lucas propose.

The bill "represents much-needed reform that will help address systemic risks that accounting standards can have on the economy," Edward L. Yingling, president of the American Bankers Assn., said in a statement.

"Mark-to-market rules have clearly exacerbated the financial crisis as institutions have been forced to report market losses rather than economic losses, resulting in a continuous downward spiral of market prices and further losses," Yingling said. "The current framework for accounting oversight, though well intentioned, has proved inadequate and must be fundamentally revised in order to provide transparent information for the benefit of investors, customers, and the public."

-- Tom Petruno

Photo: Rep. Ed Perlmutter

Comments

[W.S.]

Moving away from mark to market is just another version version of the modeling mark to magic that got us into the subprime mess to begin with

[JS]

Could we see how much money was recently given to these two (campaign funds, pet projects, brothers-in-law) to launch this?

Exactly how are these 2 politicians better qualified to make this point compared to a national body of professional auditors?

Hey, at least it's a bi-partisan effort.

Kudos to FASB for holding on thus far, let's hope they prevail.

[Bill Nolan]

I am ashamed of this nation right now. It is disgusting to watch the lengths that people will go to in order to avoid reality - how much they will flail, lie, cheat, and steal in order to avoid having to actually produce instead of simply pretend. They actually really believe that lying to shareholders is the proper solution to this mess. Hey, stealing trillions of dollars of tax money isn't good enough.

These companies have no right to exist - but for some reason they control our government anyhow.

Of course the FASB will fold and give the criminals what they want. Does anyone even doubt it? This country truly deserves everything coming to it.

[plastic]

Yes, we must protect the customer, by allowing the banks to do ENRON-style accounting. Fantasy good, reality bad for banks, govt and consumer

This kind of thing used to be called fraud. Now it's just level three accounting, and 'much needed reform'

News to Washington: We aren't all dumb, and some of us vote

[Fred, RTP, NC]

Its CONgressmen doing what they doing best:oral sex on the entire banking industry. Theyre nothing but well paid whores for their masters.

[DJ]

The New American Way, when things don't work out just change the rules.
Fictitious accounting got us into this mess, but I guess our "leaders" don't care, or worse are to ignorant to understand.
"Full Faith and Credit of the United States " is a term that no longer has any validity or substance. Unfortunately, the Day of Reckoning is here and we are unable to deceive our way around it.

[Jason]

Actually, this change has been considered now for years, and I'm happy to see some serious action to address mark to market rules. Such a change would have a sunset provision but would allow banks to keep such "losses" off the books that are crippling the industry. The market is so distorted right now, which distorts the true value of mortgage assets (which are really much higher).

As far as regulation in general, we have been smothered in regulation under the Bush Administration (Sarbanes-Oxley for example). In 2003, the Bush administration called for the most sweeping regulatory reform of Fannie and Freddie since the Savings and Loan scandal (so says the NYT!). Who blocked him? The Dems. It's time we started setting the record of this financial collapse straight.

[Old Country Boy]

Frenk Lucas is a Conservative (with a capital C). I notice the knee jerk response was to over that they were taking money (bribes) from the banks to get them off this hook. Well, Oklahoma banks are not in trouble, and are still lending money. In fact, almost all the banks here have made a concerted effort to get people out of upside down mortgages and get others into fixed rates at lower interest rates.

Back to the M-to-M rules. These originated in the EU, not the US for you EU haters. When the US finally adopted them by fiat, the market started tanking, which made the matter worse. Since then, the EU has done away with the rule. However, the US will hang on to the rule to the bitter end, because to do away with a bad rule, someone is obviously on the take. How I am sick of the knee jerk accusations, mostly on the left, but some on the right as above.

[wayne]

I would just love to understand why is it that people think that a mortage is only worth what the house is worth today.

My house is worth about $150,000. It was worth about 185,000 back in 2005. Say I bought it back than AT 185,000. I'm making the payments and am still employed. Over the life time of the loan, I would pay out around $425,000 on it with the interest.

So why is that loan only worth $150,000 at the end of the day and that the bank has to claim that they lost money on it? That's reality??

If I defaulted on it today, yes I could see that BUT I haven't defaulted on it.

REALITY would alter the "mark to market" so that it only became worth $150,000 IF I DEFAULTED TODAY. Otherwise the loan is still worth at least the $185,000 (minus whatever principle I already have paid on it) and is still actually worth the $425K of the final total payout.

THAT's reality. Projecting an immediate loss on a loan that hasn't been lost is stupid ... kind of like borrowing trillions that the government doesn't have the money to pay back.

[Trudy Self]

Mark-to-market was part of the problem going up and it is part of the problem going down. It was badly written and did not bring transparency when assets were being marked up creating fairy gold nor does it do so continually spiralling asset values down. Read Buffet's Letter to Shareholders discussing derivatives and their pricing.

[IVO]

Are any of you who are in favor of mark-to-market aware of what it does? Or for that matter, are you homeowners? Mark-to-market principles involve the fraudulent reduction in asset values based on *any* comparable sale.

Sounds good, but what does that mean? This means that when banks set their asset values they are required to include foreclosure and outlier values as their bases. Say, I live in a neighborhood of $400,000 homes. My neighbor down the street has lived in his home for 10 years and suddenly loses his job. He still owes $100k on his mortgage and subsequently forecloses because he cannot make his payments. The bank seizes and auctions off the house for the same $100k. Guess what? According to mark-to-market rules, every house in that neighborhood is now worth $100,000. So how do you think that makes a bank's books look when what was once a $400,000 asset with a $300,000 note is now a $100,000 asset with a $300,000 note, literally overnight.

This is one of the obscure stupidities enacted by our federal government that has led to this crisis (and I say one of MANY). Lets not just blame greedy mortgage companies, ignorant and irresponsible home buyers, and banks. Congress has been the one holding the match to this gas tank for years and must also be held accountable.

[pjean]

Sound like a reasonable idea? You bet it does and Newt Gingrich has been pushing for this idea for over a year.

[idoc]

of course no one mentions the fact that mark to market acct greatly INFLATED these same banks profits prior to 2007 resulting in huge bonuses to those involved.

before we even consider suspending MTM, all these crooks should be required to return those same bonuses leading up to this debacle.

[KW64]

The prior comments do not seem to reflect real study of this matter. Mark to Market is forcing curtailment of credit to an economy in great need of more credit because economicly viable activities are not getting the money required to start. If a loan is perfroming, why mark it down because the underlying asset collateral has declined in value? To take its value down and thus diminish the capital available to meet the 10% rule for lending (you must have at least 10% in capital of the value of loans made in order to offer loans) is needlessly reducing the ability of banks to lend.

What is needed is a real assessment of whether banking institutions present a risk to the public because of undercapitalization. It appears that that is all this legilslative proposal is trying to do.

[Northstar]

It is about time! This valuation undervalues assets on balance sheets and understates the true value of corporate balance sheets. I applaud this kind of congressional leadership.

[jp]

[i]including controversial mark-to-market rules.[/i]

It's not the mark-to-market rules that are controversial, it's the LACK of mark-to-market rules that causes this controversy. If there is a market, then there is an established price and I don't want some crooked CFO pissing on me by faking some other number.

You bought crap instead of assets. Take your goddam lumps already.

[Gabe]

You guys don't understand the issue "markets are not always rational." The often over shoot to the upside and the downside. Let me give you an example. You bought a 3 family house 3 yrs ago for 300k. The rents are enough to pay the mortgage. Now today the house is only worth 150k but no one makes an offer "does that mean the house is worth nothing". These accounting rules would want you to mark that asset as Zero. Now maybe if the economy gets worse it is worth 120k or possibly the economy gets better and its worth 300k again in the future. As long as the cash flow is there who cares? Now maybe a bank should only be allowed to use 75% of the value if no market currently exists or is currently illiquid but to force the mark to zero is punitive. That is why the banks are not lending. Most importantly it doesn't cost the government a penny of tax payer money!!! This might not be the best example but it give you the idea of what the banks are facing. Also the need for more regulation is just plain silly. The regulators knew about Maddof and subprime lending, and the woes of the auto industry. The government looked the other way as they were getting there campaign donations. The bottom line is the government is not even good at running the government. Imagine the politics and control the government would have if they could decided what companies and individuals got loans. It would be a political fiasco and the end to the American Economy as they guys as so corrupt that they would sell any of us out for there own special interest including the president! Clinton was such a good president because he did not have the House and Senate. He had to compromise. Obama would be a good president if he were in the same situation but because he has absolute power he is going to wreck the economy to pass a social agenda. The key to change in incremental change. For example how would it look if we had a republican president and republicans with majority in the house and Senate. They could not just say starting tomorrow no one will receive welfare it would create anarchy. Same with this president punishing wall street. Wall street and main street are the same street. Wake up all the folks with IRA's, 401ks and pensions are getting wiped out. My question is was that the plan? To make us all depend more on government so they can control more of our lives? Wake up people and open your eyes!!!

[Rick Raphael]

Investments, as opposed to speculations, are characterized by the present value of the discounted future cash flows from the investment. If all investments are required to be marked as if they were for sale today, disregarding the future cash flows, then the entire concept of investing for the future goes out the window.
FASB created an accounting scheme that only tells you what an asset is worth at this minute. If I, holding that asset, have no intention of selling it today, then there is no fair value that can be set for it other than either my cost for the asset or its value at maturity, less any current impairment of the cash flows.
By requiring asset holders to estimate fictional markets for assets that are not for sale, it has created a debt spiral where assets decline but liabilities do not. This is the scenario that created the Great Depression and, left unchanged, will create an economic firestorm of unparalleled destruction. FASB needs to be suspended immediately.

[Benedict@Large]

Duh? You think maybe they're trying to get rid of their mark-to-market rule they loved so much when times were flying high? This is just one more piece of fraud that our bought and sold Congress will legalize for their bankster crime family.

I'm curious though: Once they actually succeed in getting ALL the money from us, how do they expect any of us to repay the loans they'll be wanting us to take out?

[Benedict@Large]

@ Gabe | March 07, 2009 at 09:33 AM

I'll gladly pay you Thursday for a hamburger on Tuesday.

[Rick Raphael]

In response to Trudy Self: You are absolutely right Trudy. It's fairy dust on the way up and toilet paper on the way down. None of it makes any sense. You might also recall that Buffett said, "We endorse mark-to-market accounting." Why? Because when assets get written down he gets to buy them for next to nothing.

[Byron00]

It's hilarious reading these comments. You have people who understand the issue carefully setting out why M-to-M is such a bad idea and needs to be replaced by discounted cash flow accounting. Then you have others with no understanding at all, zero, who see a chance to snarl and spit about bank criminals, as if resentment is a substitute for intelligence. That's a very unintelligent stance to take, but par for the course in some quarters.

[Jeff]

I suppose the plan would be that when the value keeps going up irrationally during a bubble, that the banks would be able to use the market value. After all the market's judgement is the most reliable.

When the market decides the bubble prices were wrong, and tries to apply a necessary correction, then the banks are free to use their own "judgement".

All part of the plan to keep inflating bubble after bubble, until the final pop is unsurvivable.

[Lance]

Oh this is like watching paint dry with this administration, if Tiny Tim would have suspended mark to market in early February and not had him thumb up his ass, the S&P would be up for the year instead of down 25% YTD trading at 666. People wonder why banks are not lending on jumbos or anything on the commercial side - WAKE UP and suspend mark to market.

[Dave]

"I would just love to understand why is it that people think that a mortage is only worth what the house is worth today. "

They don't. Mark to market for a MBS is based on what the market is willing to pay for the mortgage, not the house. So the value of the MBS would be based on the present value of contracted future cash flows from principle and interest payments on the mortgages minus estimated losses from early payments and defaults or other expenses for administration of the accounts; then all these future cash flows are discounted based on an assumed risk that your estimations of net cash flow was too high.

[Bobz]

A lot of the arguments posted here reflect a poor understanding of mark-to-market, and give the accounting rule way too much blame for our current economic situation. To say the stock market would be up were it not for "mark-to-market" is incredulous, but I guess if you tell a lie often enough it becomes the truth. One argument that a house on your block previously worth 400,000 is sold at foreclosure at 100,000, doesn't mean all those houses are now only worth 100,000. The problem is that appraisers will say that it does weigh heavily on the value of your home so that argument doesn't wash. I am skeptical of bankers who now want to get rid of a rule that served them well during the bubble but now that reality has set it they want to dump. I hope this gets a thorough vetting in Congress before any accounting rules are changed.

[Rick Raphael]

In response to Dave who wrote: "...So the value of the MBS would be based on the present value of contracted future cash flows from principle and interest payments on the mortgages minus estimated losses from early payments and defaults or other expenses for administration of the accounts; then all these future cash flows are discounted based on an assumed risk that your estimations of net cash flow was too high."
The problem is that it's an estimate, not a sure thing and that's where I draw the line. The accountants want a precise number for the balance sheet, but because there are no quotes for Level 2 and 3 assets, they have created formulas for estimating these values. My suggestion is that we substitute mark-to cost minus current and past impairment ,or mark-to-maturity minus current and present impairment. Investors can the ascertain for themselves whether these imply future impairment of the cash flows.
The absurdity of this entire concept struck home last weekend after reading Berkshire Hathaway's Annual report. On page 18-19 referring to losses taken on derivatives contracts Buffett says, "... we have so far reported a mark-to market loss of $5.1 billion from these contracts. We endorse mark-to market accounting." Then on page 61 in a footnote to the 2008 earnings the company reports, "Includes investment gains/losses and derivative gains/losses, which, for any given period have no predictive value and variations in amount from period to period have no practical analytical value."
It seems to me that you can't have it both ways. Possible losses on a contract which comes due not earlier than 2019 are not meaningful today and do not reflect the current value of the contract, unless that contract is for sale today. The same is true of mark-to-market accounting for other companies' assets and liabilities.

[pl]

An excerpt from the FASB standards reads as follows:

"A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The principal market is the market in which the reporting entity would sell the asset or transfer the liability with the greatest volume and level of activity for the asset or liability. The most advantageous market is the market in which the reporting entity would sell the asset or transfer the liability with the price that maximizes the amount that would be received for the asset or minimizes the amount that would be paid to transfer the liability, considering transaction costs in the respective market(s). In either case, the principal (or most advantageous) market (and thus, market participants) should be considered from the perspective of the reporting entity, thereby allowing for differences between and among entities with different activities. If there is a principal market for the asset or liability, the fair value measurement shall represent the price in that market (whether that price is directly observable or otherwise determined using a valuation technique), even if the price in a different market is potentially more advantageous at the measurement date."

If the assets are truly marked to market as described above, why would the above rule run counter to the public interest? If the expected value of the cash receipts (rents or mortgage payments) is greater than the underlying asset (the property), wouldn't the assets be marked to the most advantageous or higher value? Wouldn't the principal market in which the reporting entity would sell the asset become the investor market if that is the market in which the reporting entiry could sell it at the present time? For example, couldn't a bank with a loan secured by the property, sell that property to an investor for more than it could a consumer, if the discounted cash flows are greater than the consumer market for property? Perhaps the issue is that the assets are being marked to the most conservative market and not that which is proper for the current market. If there is truly more value in the assets than reported, then the accounting rule has been inappropriately applied. If there is not, the accounting rule has worked as designed and disallowed the inclusion of value in the asset lending base that does not exist.

[rick raphael]

I think the problem is that the assets are being marked to the most immediate market, not the "most advantageous market"; a market which clearly does not exist at this time. Again, in my opinion, mark-to-market destroys the time horizon for long term investors. If the financial services companies are destroyed in the next couple of months, you will find very quickly a market for these assets. But I think that's unlikely to happen.
More likely is that either the government will create a guaranteed market for the assets or the accounting rules will be changed. Since option two moves the risk away from the government to the markets, I think that option one, while greatly discussed over the past six months, will be reserved as a last resort. And that's why it hasn't been used thus far.
Two economists, Wesbury and Stein, wrote an article for Forbes on 2/26 entitled "Why Mark to Market Accounting Must Die". They say, "Two things are absolutely essential when fixing financial market problems: time and growth. Time to work things out and growth to make working those things out easier. Mark-to-market accounting takes both of these away."
In addition, they add with regard to the historical perspective, "Mark-to-market accounting existed in the Great Depression, and according to Milton Friedman, who wrote about it just 30 years after the fact, it was responsible for the failure of many banks.
Franklin Roosevelt suspended it in 1938, and between then and 2007 there were no panics or depressions. But when FASB 157, a statement from the Federal Accounting Standards Board, went into effect in 2007, reintroducing mark-to-market accounting, look what happened."
I hope that those who are convinced of the disaster ahead of us will contact the House Financial Service Committee and let them know your opinion. For myself, well I can find no time in the past 100 years when the Dow has declined 49% in ten months. And I know that 1st quarter earnings will start arriving in late April. If Friedman is right, we have about 3 weeks to change FASB 157 for 1st Quarter accounting before all hell breaks loose. Dow 4000?

[Ian]

M to M is somehting that should only be used when the assets are actively traded by the company. Where the intent is to hold to maturity it does not make sense. A very simple example would be purchasing a five year fed gov bond with cash that will not be needed for over five years. If the interest rates go up, the market value of the bond drops and the company has to show a loss. This is crazy. The gov isn't going to default and at maturity it will be worth it's full face value. The only "loss" is the opportunity to earn a higher interest rate on the initial investment. Conversely, if the company has to carry the bond on the books at market value, as the maturation date approaches, they will start to see artificial profits which did not actually occur. In what way is this transparent to investors? This needs to be changed. The application of M to M should be based on intent to market and not be applied to primary debt instruments that have not defaulted. I can understand having to impair the value of an debt security based on the credit rating of the debtor but then that assumes that the debtor's CR is accurate. It just does not make sense to have to mark down the value of an entire asset class when there are problems with some its members. The banks holding mortgages are seeing huge losses in capital for an invalid reason. According to an AP report on March 5th, 12% (5.4m) of mortgages nationwide are behind on at least one payment. That means that over 88% of the mortgages nationwide are still current. With M to M, the value of those 88% has to be reduced even though there is no sign that the mortgages are going to default. According to an FHA release last Septmeber, the average mortage is $184,282, which gives a total of $7.3 trillion of performing mortgages. Having to write the balance sheet values of these down has wiped out over $1.8 trillion in bank capital for no reason (using a conservative 25% chargeoff). Assuming these mortgages continue to perform through maturity, the banks that have not been shuttered do to low capital ratios will start showing huge "paper" profits. The mark to market valuation of debt instruments being held to maturity needs to stop now. Let the banks reprice performing loans back to the outstanding balances and only force M to M on non-performing loans and and properties aquired as collateral on those loans.

[mr.bilko]

@rick raphael and @Ian
Very well written. I've brought up many of these same issues with various people. It's unusual to see comments on Petruno's blog by people who actually understand mark-to-market and why it needs to be suspended.

[Jon]

The MTM that the banks want to suspend is SFAS 157 which was introduced in 2006 with an effective date for financial statements after 11-15-07. The FASB & SEC encountered objections and delayed the enforcement until 11-15-08. Before SFAS 157, assets that were held for trading were marked-to-market. SFAS 157 wants all assets and liabilities to be marked-to-market.

Part of what is going on is a clever use of the English language. If the FASB and the SEC had called it “Unfair Value Measures” and the subset marked-to-trades-in-an-irrational-market, no one would have taken it seriously. Instead SFAS 157 and 159 use the phrase “Fair Value” over 1,400 times to assure us that this method is fair.

Please remember that the FDR administration suspended a similar Mark-to-Market system in 1938. Actually the SEC provides additional details on the same 1938 suspension on page 44 of their 12-31-08 report to Congress in their “Study on Mark-to-Market Accounting”.

Some of the basic flaws in the new MTM accounting measures are:

1. Bankers make loans based on projected cash flow. The MTM measures ask the bankers to carry the loans at values similar to recent trade prices, not at cost or values based on cash flow. With disrupted markets, the trade prices can fluctuate over a wide range. Very few assets have escaped recent wide market price fluctuations. Some that have escaped are cash, treasuries and conforming mortgages. Any other assets that the banks might invest in have recently had wide market price fluctuations. The change from cash-flow valuation to trade-price valuation has destroyed billions of dollars of equity. (See the 11-15/16-08 WSJ article on Fannie & Freddie. The chart shows the equity difference between the GAAP accounting in effect 9-30-08 and “Fair Value” accounting in effect for financial statements after November 15, 2008. The difference is roughly $70 billion less equity under the new accounting measures.) For assets that the banks intend to hold to maturity, MTM is useless and misleading.
2. MTM destroys predictability. The financial companies cannot mark-to-market until they have figures for the trade prices. This means huge surprises when the companies report their earnings. They can predict their cash flow, but not the end-of-quarter trade prices and resulting valuation changes.
3. Under the new MTM rules, a financial institution can have a positive cash flow and a huge phantom loss from MTM adjustments. The lending patterns have been changed and many financial institutions have had to dilute their equity.
4. SFAS 157 wants all assets and liabilities to be marked-to-market. This means that a TARP contribution creates a phantom loss and reduces equity. (The TARP contribution improves the credit-worthiness, which increases the market value of the Company’s liabilities. Under SFAS 157 this translates to a loss, since the Company would have to pay more to buy-back their own liabilities. The loss reduces the equity.)

The SEC and the FASB have actively defended SFAS 157 and 159. The Statements themselves, the amendments and the SEC’s 12-31-08 letter to Congress total over 400 pages. It appears that they had good intentions, but the volume of amendments and explanations indicate that there were unintended consequences.

An interesting side question is who benefited from this recent accounting change?
1. Some of the regulators are hiring while the banks are laying workers off.
2. Articles have mentioned short sellers benefiting. (In addition to regular short-sellers and naked-short-sellers, also think about SKF and similar issues on the NYSE) In addition, public firms are getting seriously hurt and some private and foreign firms are benefiting. (Think of the Lehman assets that were sold at distressed prices to Barclays and the Japanese securities company and the Merrill mortgage assets sold to a private TX hedge fund and the recent private offer for IndyMac assets, or the Nevada bank assets that went to PennyMac or the recent purchases by Wilber Ross etc.) Private and foreign firms are benefiting from the U.S. public companies’ MTM challenges.

Steve Forbes keeps reminding us that some of the Bush-era policy changes contributed to the financial crisis. I also appreciate him reminding us that some of these policies, such as MTM, have been tried before. I remember well that “Those who do not learn from history are destined to repeat it.”