[Rhodes22-list] Accounting

[Brad Haslett]

The SEC finally suspended FASB 157 "mark to market" rules, a bit late
I might add.  For an old guy, McCain stays up with things. Here's what
he said about that in march.

In March, John McCain Called For A Meeting Of Accounting Professionals
To Analyze The Current Mark To Market Accounting Systems. "[I]t is
time to convene a meeting of the nation's accounting professionals to
discuss the current mark to market accounting systems. We are
witnessing an unprecedented situation as banks and investors try to
determine the appropriate value of the assets they are holding and
there is widespread concern that this approach is exacerbating the
credit crunch." (John McCain, Remarks, Santa Ana, CA, 3/25/08)

A good primer on "mark to market" below-

Brad



September 30, 2008
The Trillion-Dollar Question: Are the Bookkeepers At It Again?
By Jim H. Ainsworth
Why should America attempt an expensive, controversial, and possibly
ineffective bailout strategy for the current financial crisis when a
virtually costless and simpler change could solve much of the problem?

We accountants don't like publicity. Fortunately, we don't get much.
Most of the public remembers Enron, but fewer remember
Arthur-Andersen, the big accounting firm that went down with them.
Questionable accounting was a big part of the reason for Enron's
failure. I think accountants may be behind the scenes again in the
current financial crisis. Are there any of us bean counters in those
meetings? If there are, my bet is that they are sitting on their hands
and keeping their mouths shut even though they might know about a much
better (and cheaper) solution. Accountants, after all, don't talk
much; and they don't like to admit errors.

Pouring 700 billion of our money into failing financial institutions
seems akin to throwing spaghetti against the wall. Keep throwing until
something sticks. They tell us that credit will dry up if we don't
inject cash. No credit would be disastrous for the economy, but they
have not explained well enough why the banks have failed so suddenly
and drastically that emergency room surgery is required. Knowing why
would help us poor taxpayers feel better about how the problem should
be solved. Ever wonder how many other bank failures are out there
waiting behind the curtain to take their bows? Are we going to throw
even more money at them too?

Should we consider a solution that requires no money, or at least a
lot less? Here's one. Have the SEC suspend the accounting rule called
mark-to-market. By a relatively simple accounting adjustment, troubled
banks' assets and capital could be increased and credit kept
available. Accounting purists, cover your ears. Eyes glaze and minds
wander when I say balance sheet, so let's use the acronym BS, a more
appropriate description. BS's have two sides: assets on the left,
liabilities and capital on the right. Banks are required to maintain
certain levels of capital (the difference between assets and
liabilities) in order to make loans. When assets shrink, capital
shrinks. When the ratio of capital to assets drops to a certain level,
(think ten-to-one), banks are not allowed to make loans. And if it
drops too low, they can be classified as insolvent. This can happen
overnight, and it did.

Why? Wall Street is essentially driven by emotion and the news of the
day, so when nobody wants a particular security, the price falls fast
and hard. Do I believe in efficient markets? Yes, eventually, but
markets are often wrong for periods of time ... think years.
Therefore, we are marking assets down to near zero based on markets
that fluctuate wildly from minute to minute. The media have hammered
us with news about drops in home prices and increases in mortgage
delinquencies to the point that nobody wants to own these assets. A
few rotten apples have spoiled the whole barrel. Sub-prime loans and
the securities they are bundled into have plummeted in value,
sometimes to zero, because nobody wants to touch that barrel, even if
most of the apples are still good. Banks marked them to their current
value, billions in capital disappeared with the stroke of a pen
(excuse me, stroke of a key.)

So why do we have mark-to-market? Accountants have always had a hard
time figuring how best to state asset value on a balance sheet. We
depreciated buildings in years when their value was skyrocketing and
thus understated asset values and capital. When interest rates shot up
in the Seventies, banks owned tax-free bonds yielding two to three
percent and had long-term loans at 6%. You could buy identical bonds
with yields double or triple that and make loans at 20%. The market
value of these banks' loans and bonds dropped by more than half. If
they had marked to market, regulations would have prohibited many of
them from making future loans. Many would have been declared insolvent
and taken over by the FDIC. Yet, these banks were essentially sound.
They held their loans and bonds to maturity and only suffered
temporary market losses that were never realized or reported.

CPA's continued to struggle with asset valuation. What is fair? What
is conservative? Enter Enron. Inside accountants at Enron recognized
correctly that valuing assets at cost was often invalid, so they
started playing fast and loose with asset values, using something
called mark-to-model. A sharp CPA could design a believable computer
model that could make the value come out wherever his boss wanted it
to be. He could also convince outside auditors and regulators of the
soundness of his model.  Embarrassed that they had been caught looking
the other way, FASB (Financial Accounting Standards Board) passed rule
157 that requires assets to be marked to market. Asset valuation based
on the optimism of its owner was replaced with the skepticism of a
risk-averse buyer. Sounds nice and conservative.

Enter the law of unintended consequences.

Suspending the mark-to-market rule would allow banks and accountants
to revalue their assets based on more sound criteria than the euphoria
or panic that pervades the floor of the New York Stock Exchange
minute-by-minute. Sub-prime mortgages will likely have much higher
values if considered in a longer-term perspective -- such as
hold-to-maturity. I believe that the vast majority of mortgages will
perform in the long term.

Presto. Up goes assets; up goes capital; banks can make loans again.
Cash infusions may still be required, but this will buy us enough time
to seriously examine what steps need to be taken to get runaways like
Fannie and Freddie under control, how to renegotiate rates with
distressed borrowers who really can handle a mortgage, and how to keep
this from happening again. Can this be done? If we can approve 700
billion, surely we can do this and keep our money.

Jim H. Ainsworth-former CPA, CFP, CLU, Registered Investment Advisor,
Licensed Securities Principal, was twice named one of the most
influential accountants in America by Accounting Today magazine.  He
welcomes comments at http://www.jimainsworth.com

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at October 01, 2008 - 07:06:42 AM EDT