Banking, finance, and taxes
FASB Bring Sense, and Cents, To Banks & Mark-to-Market (C, WFC, BAC, JPM)
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The Financial Accounting Standards Board, or FASB, has voted to loosen its rules for the (now dreaded) balance sheet act of mark-to-market valuation for accounting. Many will argue that this is unfairly giving clemency to the troubled banks and financial institutions. Some will argue that it violates free market principles. And some will argue that it will save the system and limit the amount of extra capital needed in the system. The term “toxic assets” will now be called something to the tune of “underperforming assets” or “exceptional assets.”
Citigroup, Inc. (NYSE: C) and Wells Fargo & Co. (NYSE: WFC) have been on record noting that the mark-to-market standard does not work in the current periods of inactivity or illiquidity. This morning Ken Lewis of Bank of America Corp. (NYSE: BAC) told CNBC’s Becky Quick that it is a mark-to- maturity company as the bank holds the loans. Jamie Dimon of JPMorgan Chase & Co. (NYSE: JPM) has defended mark-to-market, but with some exceptions and without the ultimate endorsement. Even if you do interpret Dimon’s statements as supporting mark-to-market in all cases no matter what, you can always expect the guy with the strongest books that can hold up to any storm to say everyone else should be that way.
The first exception is regarding illiquid markets and valuation of these items. According to one of the spokespeople for FASB, this has been approved in a vote. The rest of the votes on valuation exceptions in mark-to-market will be discussed in a conference call at 11:00 AM EST. Yes, we’ll be on it. No formal announcements have been made on the vote outcome for the other issues around mark-to-market actions as of 10:30 AM EST.
The issue for the total purists in free market theory is that these banks should have to instantly mark assets to whatever is the current fair market price. According to that argument, it gives analysts a fair price of the true value of the bank at any and every snapshot in time. The problem is that this requires banks to put up capital against “bad loans” and “bad assets” with “good capital.” This notion also puts most large banks at times of illiquidity or at times of instant distress as being mathematically insolvent.
If I have a bank loan of $50,000.00 and am paying down my loan on time, but I have two neighbors who are not then in theory the bank still has to mark the value of my loan down. It is performing, but the related risk is there in some accounting models. That may be the simplest and crudest 50 word explanation out there, and it greatly understates the crisis situation we have been facing over the last year.
Another crude explanation of mark-to-market is in many of these mortgage derivative products. If a bank holds these and the markets are illiquid, even a small trade of $1,000,000 worth of these at thirty-cents on the dollar in theory makes the bank mark assets classified as being mostly the same down to $0.30 per $1.00. It might not matter if the real value is $0.75 based upon how the overall pool is performing. Again, this is a bastardized short explanation that greatly understates the real financial crisis of the last year.
But whether these are bastardized or crude and overly simplified explanations, the problem is that complete mark-to-market without exception causes the banks to put up good capital in reserves to offset the new lower market value of bad assets. That in turns takes up capital that could be used for new loans, and as you have seen over the last year creates a situation where the banks have to raise additional capital from the market or go to Uncle Sam with hat in hand. When the markets are shut off or illiquid, this can create the feared death-spiral for lending institutions.
The incentives to sell assets into the distressed pool in the latest Treasury plan probably just went down. And the “new value” is going to be higher to something that is at least more “performance based” rather than compared to an outside number that may or may not be the case. You can count on the critics already putting together the reports that many banks are fudging or that they will fudge on what they interpret as a value compared to a real value. Either way, the banks just got the first part of a game-changing event that will loosen up the need for future capital and future taxpayer dollars.
Jon C. Ogg
April 2, 2009
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