SEC, FASB: No Market? Use Future Cash Flows; Big Four Chimes In

SEC, FASB Resist Calls to Suspend Fair-Value Rules

The SEC and FASB issued ``clarifications'' today on how banks should interpret existing rules that require them to review their assets each quarter and report losses if values have declined. A suspension isn't being considered.

Congressmen, banking lobbyists and companies including American International Group Inc. have urged the SEC to place a moratorium on fair-value accounting, saying it forces firms to report losses that they never expect to incur. Federal Reserve Chairman Ben S. Bernanke and other proponents say a suspension would erode confidence that firms are owning up to losses.

``In the past couple of weeks, fair-value accounting has been under attack,'' JPMorgan Chase & Co. analyst Dane Mott wrote in a report today. ``Blaming fair-value accounting for the credit crisis is a lot like going to a doctor for a diagnosis and then blaming him for telling you that you are sick.''

``Suspending the mark-to-market prices is the most irresponsible thing to do,'' said Diane Garnick, who helps oversee more than $500 billion as an investment strategist at Invesco Ltd. in New York. ``Accounting does not make corporate earnings or balance sheets more volatile. Accounting just increases the transparency of volatility in earnings that already exists.''

SEC Clarification May Help Markets

The Securities and Exchange Commission and the Financial Accounting Standards Board have just made an announcement that, dry as it sounds, may mean a great deal: "When an active market for a security does not exist, the use of management estimates that incorporate current market participant expectations of future cash flows, and include appropriate risk premiums, is acceptable."

The SEC is not telling holders of hard-hit mortgage-backed securities that they can willy-nilly slap any value on them they want.

Today's SEC rules clarifications do not end mark-to-market accounting. But they do let the holders of these low-value "toxic assets" to use other ways to value them, which probably will lead to an increase in their value, even though that is not the SEC's intention.

Auditors Resist Effort To Change Mark-to-Market

U.S. accounting firms, which had been silent on the $700 billion financial-rescue package rejected by the U.S. House of Representatives on Monday, are opposing congressional efforts to scrap mark-to-market accounting rules.

"It's just bad for investors," said Beth Brooke, global vice chair at Ernst & Young LLP, in Washington, D.C. "Suspending mark-to-market accounting, in essence, suspends reality."

"It's absolute idiocy," said Barbara Roper, director of investor protection for the Consumer Federation of America. "Allowing companies to lie to investors and lie to themselves is not the solution to the problem, it is the problem." “the alternative to mark-to-market accounting is mark-to-myth" and could give banks and other financial companies the freedom to value assets at inflated amounts.

Thirsty for Changes to Mark to Market?

Would suspending mark-to-market rule solve the financial crisis?
Kevin Kersten at bloggingstocks provides this amusing example:

Let me give a silly but simple illustration. If you have 20 one dollar bills in your wallet, we would all agree you have a net worth of $20. Thirsty Bob also has one dollar bill in his wallet and walks into the break room and wants to buy a Coke. Soda in the machine costs 50 cents, but it only takes quarters. Thirsty Bob asks if anyone has change and they all say no. Sam says he has only two quarters and will trade Thirsty Bob -- who is really thirsty -- two quarters for a dollar. Thirsty Bob quickly agrees to take Sam up one his offer in order to get the Coke now. Bob knows that two quarters for a dollar is a bad deal, but he is takes the deal anyway.

According to mark-to-market accounting, you, with your 20 dollar bills, now have a net worth of $10. Even though you are still holding the exact same 20 one dollar bills you held in your hand when you entered the room and even though you did not trade with anyone else in the room, the current public market in the room for $1 bills is 50 cents. If each of those $1 bills is worth two quarters, your net worth is only 40 quarters, or $10. You must evaluate your net worth based on the current market. You are smart enough to know that the one dollar bills are really worth four quarters at the bank down the road, but mark-to-market accounting will not allow you to use this "long term" evaluation method.

This, in essence, captures the problem of the current loans crisis. One dollar bills are the mortgages nobody is willing to buy. Banks must evaluate them at the depressed rates they occasionally trade at and everyone is feeling poorer.

Mark to Market...the Song that Never Ends

More and more on mark to market accounting. Some controversial views are expressed by various writers in the sources noted below and in other sources quoted in earlier postings. But as an accountant in the post-Enron world, it's tough to understand why anyone would want less informative or less transparent accounting disclosure. It seems counter-intuitive that less conservative accounting would help financial markets. None of the arguments made so far present a clear picture as to why any financial institution has been harmed by mark-to-market rules--what we have seen is mostly dubious scare tactics along the lines of "mark-to market is the next plague, so we need to get rid of it." We need bankers to be more specific about this if they want to justify new or different rules.

Suspend Mark-To-Market Now! By Newt Gringrich
Reform or Bust: Because existing rules requiring mark-to-market accounting are causing such turmoil on Wall Street, mark-to-market accounting should be suspended immediately so as to relieve the stress on banks and corporations. In the interim, we can use the economic value approach based on a discounted cash flow analysis of anticipated-income streams, as we did for decades before the new mark-to-market began to take hold. We can take the time to evaluate mark-to-market all over again. Perhaps a three-year rolling average to determine mark-to-market prices would be a workable permanent system. It is not widely understood that the adoption of mark-to-market accounting rules is a major factor in the liquidity crisis which is leading companies to go bankrupt. But it is destructive to have artificial accounting rules ruin companies that would have otherwise survived under previous rules. Also:The Congress should repeal Sarbanes-Oxley, which failed to warn of every single bankruptcy!!

Mark to Market Accounting: Kill It Before It Eats Us Alive
However, mark to market rules distort financial results and business decisions under the false cloak of conservatism. The rules make little sense, produce inconsistent results, lack a basis in reality and provide lots of room for abuse.

FASB, SEC Discuss Fair Value-Standards
The FASB is in discussions with the U.S. Securities and Exchange Commission about whether additional guidance on fair value accounting rules is needed, according to a person familiar with the matter. SEC spokesman John Nester said the SEC is "working closely with U.S. and international regulators and standard setters on the issues related to fair value." It was unclear whether the SEC and FASB would issue guidance before the end of the third quarter, which ends on Tuesday.

First Nail in the Coffin of FASB?
Lots of press on mark to market accounting. For accountants, a potentially disturbing piece of the financial rescue plan includes powers for the SEC to suspend FAS 157 if it pleases. More ominous is a study on how accounting standards are developed and whether the standards need to be changed. This shows the impact of the combined eforts of Wall Street Lobbyists and the American Banking Association on the negotiations in Washington over the past week. See various articles and blog postings below.

Bailout Bill Gives SEC Sweeping Power to Halt Fair Value
The critics of fair-value accounting have apparently gotten a hearing on Capitol Hill: The current bailout bill being debated today in Congress includes sections giving the Securities and Exchange Commission power to:

• suspend mark-to-market accounting "for any issuer" and to launch a probe into the question of whether it contributed to the crisis. Under the securities laws, the SEC would have the authority to "suspend, by rule, regulation, or order, the application of Statement Number 157 of the Financial Accounting Standards Board for any issuer...if the Commission determines that is necessary or appropriate in the public interest and is consistent with the protection of investors," according to Section 132 of the bill.
• launch a study of the effects of 157 on financial institutions, including depository institutions. The study would mull the effects of the standard on bank balance sheets; the impact of fair-value accounting on this year's bank failures; and how mark-to-market affects the quality of financial information provided to investors.
• probe how FASB develops accounting standards; whether it's advisable and possible to change the standards; and "alternative accounting standards to those provided in such Statement Number 157."

Fed & Treasury Needs to Stop Targeting Asset Prices
What the Fed, Treasury and SEC seems to fail to understand is that you CANNOT get a return to normalcy after a bubble -- not until prices are allowed to fall to levels that bring in aggressive buyers. That is true for stocks, houses, and even financial institutions. The plan as it is currently constructed fails to recognize that Housing prices still remain elevated, more foreclosures are likely, and that another 10-20% downside in real estate is quite likely. Instead of focusing on asset prices, we should be looking at recapitalizing the banking institutions, providing liquidity to those that need it, and managing insolvency via FDIC. Its time to fix what's broken, and leave the assets pricing to the markets.

Wall Street's defrocked high priests lick their wounds
Section 132 of the rescue plan Troubled Asset Relief Program (“TARP”) is headlined: Authority to Suspend Mark to Market Accounting. It should have been called: Authority to Suspend Reality. During the boom, it seems market prices were perfectly acceptable, a function of supply and demand. Now, during the crash they are considered "fire-sale". But how will bean counters arrive at a more appropriate price for assets? Perhaps they can now be determined by a committee.

The ‘Compromises’ in the Bailout Bill
Meanwhile, the most interesting new provision is one allowing the Securities and Exchange Commission to suspend mark-to-market accounting. As you may have heard, the mark-to-market requirements have been cited as one of the causes of the current financial-institution liquidity crisis.

After the Deal, the Focus Will Shift to Regulation
In any case, it is too late to abandon mark-to-market accounting. Just how reassuring to investors would it be for the government to issue a rule saying it is O.K. for banks to value assets for far more than anyone would pay for them?

The House Republicans’ Alternative Rescue Plan
Repeals of various kinds of regulation are on the table. Some Republicans want to roll back parts of Sarbanes-Oxley. A number have advocated changing mark-to-market provisions — the rules that say companies have to value assets according to what they’re currently worth on the market (which, for some assets right now, is not very much, or at the very least hard to calculate), rather than according to what they initially cost or through some other fundamental analysis.

Should Mark-to-Market Provisions Be Suspended?
It’s crazy to let strict adherence to an accounting rule cause so much damage.
vs.
I think the right answer may be that firms with fundamental value not reflected in current mark to market prices should find a way to explain that to their investors. These explanations would not be GAAP-consistent [that is, hewing to generally accepted accounting principles], but as long as they are described as such, there is no prohibition against such explanations. I am actually surprised that this is not used more often. Unless, of course, there is no fundamental value….

Mark to Market Accounting Consequences of Bailout Explained

Excellent article here on how mark to market accounting affects the current investment bank bailout proposal.

Also, in a reaction to the financial crisis, the International Accounting Standards Board has called a special meeting to discuss the IFRS rules on accounting for financial instruments, which is where the fair value and mark to market accounting rules exist.

Former SEC Bosses: Keep, Expand Fair Value Accounting

In an editorial "How to Restore Trust In Wall Street" in the Wall Street Journal, Arthur Leavitt, a former SEC chair and and Lynn Turner, a former SEC chief accountant make the case for more and better, not less, fair value accounting .

• Banking and financial services trade groups are aggressively lobbying the SEC to suspend the mark-to-market, or fair-value, accounting standards, claiming that fair-value accounting standard has distorted banks' balance sheets, and has contributed to the market volatility.
• On the contrary, that gets things backward--it is accounting sleights-of-hand that hid the true risk of assets and liabilities these firms were carrying, distorted the markets, and caused investors to lose the confidence necessary for markets to function properly.
• Restoring public trust requires better quality, accuracy, and relevance in financial reporting and expanding, not reducing fair value reporting of the securities positions and loan commitments of all financial institutions.
  Only fair value accounting brings transparency to the market and determines whether or not a financial institution has sufficient capital and liquidity to justify receiving loans and capital.
• Contrary to what the critics claim -- fair value is not liquidation value. It does not reflect ultimate settlement amounts, but the current value in arms-length transactions. It is an accurate reflection of the value of an asset or cost of a liability, and what taxpayers should pay for assets.
• Those who blame fair-value accounting for the current crisis are shooting the messenger. Fair value does not make markets more volatile; it just makes the risk profile more transparent.
• Blame lies with Lehman, AIG, Fannie Mae, Freddie Mac and others who made poor investment and strategic decisions and took on dangerous risks--blame should not be placed on the process by which the market learned about the them.
• Tough medicine must be taken in order to vastly improve financial reporting, bring transparency to the markets.

Lawyers Push Back on Accountants

Lawyers and companies objecting to more disclosure have derailed FASB by a year on the deadline for companies to provide new disclosures about their lawsuits and other contingent liabilities. The proposals are part of a controversial rewrite of FAS 5. Companies said they could not implement the new policy for disclosing potential lawsuit liabilities in time. The FASB is still digesting 235 comment letters from lawyers, auditors, and financial statement preparers who are concerned the newly shared information would reveal confidential data and give away the store in litigation. Companies would be required to disclose "specific quantitative and qualitative information" about potential lawsuit liabilities, including maximum amounts of claims, unfiled claims, and providing in tabular format lawsuits showing various stages of probability and potential outcomes.

Investors love it--and have encouraged even more disclosure. Lawyers hate it. Must be something good about it?

Read the FASB's proposal.
A few articles:
WSJ-Law File: Merck, Pfizer, Eli Lilly, J&J, Novartis and Wyeth, the companies told FASB that that estimating the costs of continuing litigation is “highly subjective, subject to huge swings as underlying assumptions change, and unlikely to provide financial statement users with meaningful or reliable information.” Others, including GE, DuPont, Boeing and McDonalds, have also objected to the rule.
WSJ editorial from last week on the proposed rule: FASB's Lawyer Bonanza
The American Bar Association's take on it.

Bernanke: Put Mark to Market on Hold

Reflecting the views of Wall Street firms and their lobbyists, the Wall Street Journal has written at length about suspending mark to market rules as part of the resolution of the current financial crisis. Bloomberg has remained silent until this morning when they published a commentary by John M. Berry.
His points on the mark-to-market issue:

• As Bernanke has stated that the government's proposed buyout should be based on ``hold-to-maturity price'' for mortgage-related assets, institutions would receive double the proceeds if held-to-maturity prices were the basis for buyouts of their CDO positions, providing them with a substantial infusion of capital.
  
• The government can hold the assets for an extended period, so such pricing might be justified.
• Buyouts should be based only on hard-headed, realistic estimates of the probabilities of default of the underlying mortgages.
• American International Group Inc., was carrying long-term mortgage-backed assets at almost 70 percent of their par value on the basis of hold-to-maturity, while Lehman Brothers Holdings Inc. held them at less than 40 percent of par on a mark- to-market basis.
• Hold-to- maturity pricing has been seen as nothing more than an accounting gimmick used to avoid telling the truth.
• Bernanke has been critical of mark-to-market accounting regarding long-term assets and bank loans, as well he should be. Such rules didn't cause the current crisis. On the other hand, when the mortgage-backed asset market ceased to function, it was absurd to insist on its use, and it certainly has made matters much worse than they had to be.

Paulson/Bernanke: Need Bright People to Figure Value of Mortgage Assets

Bernanke Goes Off Script to Address Fire-Sale Risks
Sudeep Reddy at WSJ
Ben Bernanke argues for not buying assets at fire-sale prices in the Treasury’s $700 billion bailout. Uncertainty in housing markets and the economy are forcing financial institutions to mark mortgage securities at fire-sale prices, rather than their value if held to maturity, effectively creating a vicious circle of more write-downs that further depress asset values, Mr. Bernanke explained. Bernanke essentially argued that fire-sale prices would hurt markets even further and wouldn’t solve the problem facing the economy. “We cannot impose punitive measures on institutions that choose to sell assets.” Still, he acknowledged that the precise approach to doing so hadn’t been determined, arguing for flexibility. “We do not know exactly what the best design is,” and that would come from consultation with experts, Mr. Bernanke said. Bernanke distinguished between, on the one hand, “fire sale prices,” the ones that prevail “when you sell into an illiquid market” and, on the other, the prices that holders think the assets are really worth, sometimes described as “fundamental” values or “hold-to-maturity” value. “The holders have a view of what they think it’s worth. It’s hard for outsiders to know,” Mr. Bernanke said. The point of an auction is to reveal those prices. “If you have an appropriate auction mechanism… what you’ll do is restart this market,” he added.
Paulson, while seeking maximum flexibility, said the Treasury is considering doing auctions one asset class at a time. He said they aim to bring “bright people” to work on the challenge of designing market mechanisms.

Wall Street says Accounting Caused Meltdown

It's obvious that lobbyists for Wall Street firms are taking a hard line of suspending or revising mark to market rules (for a review of the basics go here). The WSJ has several articles a day over the past few days citing the FAS 157 rules as the villains of the current meltdown. The Washington Post summarizes some of their comments in the excerpt below. Accountants quoted are generally on the defensive. University profs are divided on the issue.

Wall St. Points to Disclosure As Accounting Rule Cited in Turmoil
Carrie JohnsonWashington Post September 23, 2008

Wall Street executives and lobbyists say they know what helped push the nation's largest financial institutions over the edge in recent months. The culprit, they say, is accounting. Lynn E. Turner, a former SEC chief accountant, said he remembered fielding questions about the accounting provision six months ago from lawmakers on Capitol Hill. "What the banks are telling everyone is that the accounting has caused the problem," Turner said. "The only thing fair-value accounting did is force you to tell investors you made a bunch of very bad loans." "[Mark to market rules are] intended to be more or less for orderly markets," said Dennis R. Beresford, an accounting professor at the University of Georgia. "But we don't have orderly markets these days. It's not so much that mark to market has people complaining, but marking to a particular market. Today it's more kind of fire-sale prices."

Martin Sullivan, chief executive of AIG, decried fair-value accounting in a February conference call with investors and called for regulators to make changes after AIG took an $11 billion write-down this year. Joe Norton, a spokesman for AIG, declined to comment yesterday.
Arizona Sen. John McCain, the GOP presidential candidate, mentioned fair-value accounting as a problem in a recent stump speech.

Banks also have been fighting their auditors, some of which have reasoned that downmarket conditions have persisted for so long that assets are no longer "temporarily impaired" but now require write-downs and capital infusions. Banking trade association officials are scheduled to meet with SEC regulators this week to discuss the issue, which could prompt some banks to attract new capital to meet regulatory requirements. "The accounting rules and their implementation have made this crisis much, much worse than it needed to be," said Ed Yingling, president of the bankers' association. "Instead of measuring the flame, they're pouring fuel on the fire."

The odds of a wholesale regulatory reversal in the near term, however, are slim, according to two sources briefed on the process, because a shift away from fair-value accounting would only intensify trouble with pricing complex assets in an unruly market. The sources spoke on condition of anonymity because they were not authorized to speak publicly about the matter.
"It is extremely unlikely they are going to back off of market-value accounting in the midst of a crisis," said a financial services policy expert with long government experience. "When things stabilize, I guarantee you that you're going to see a revised procedure."

J. Edward Ketz, an accounting professor at Pennsylvania State University, says he "doesn't buy" the argument that fair-value accounting is a root cause of the problems. Executives never complained about mark-to-market accounting standards when they helped banks post huge gains on derivative investments during the economic boom, or when fair-value accounting for stock options produced tax benefits, Ketz said. "If anything, I think that market-value accounting has helped to bring the problems to a head earlier and with less damage, than if market-value accounting hadn't been applied," said Charles W. Mulford, an accounting expert at the Georgia Institute of Technology.

New York Times: Treasury Gets a Pass on Mark to Mrket

Mr. Rosner says that the draft bill “prevents judicial review that could allow the protection of decisions that create false marks, hide prior marks, or could be used to prevent civil or criminal prosecution in situations where a management knowingly provided false marks that aided the growth of this crisis of confidence.”

After Bailout Treasury Gets a Pass on Mark to Market

New York Times: After Bailout Treasury Gets a Pass on Mark to Market
...the draft bill “prevents judicial review that could allow the protection of decisions that create false marks, hide prior marks, or could be used to prevent civil or criminal prosecution in situations where a management knowingly provided false marks that aided the growth of this crisis of confidence.”

Billionaire Wilbur Ross: Mark-to-market was a mistake
Emily Chasan, Reuters September 22, 2008

Rules requiring financial companies to value assets at current market prices were a mistake and their implementation was botched, billionaire investor Wilbur Ross said on Monday. "I think it was a huge mistake -- both the general concept of it and more specifically the way that it was implemented," Ross said. He said the main problems with the rules, were that accounting treatments for the exact same security can be different for different companies, based on whether they decide to hold them to maturity, or mark-them-to market as part of a trading portfolio. Similar inconsistencies also affect mark-to-market rules about the valuation of complex securities, like credit default swaps, Ross said. "If I write credit protection as a credit default swap I have to mark it to market," Ross said. "But if I write it as a monoline insurer there is no mark-to-market, even though I'm taking precisely the same risk."

While Ross said the market does need more transparency about hard-to-value assets that have triggered billions in write downs at financial institutions over the last year, he felt that the mark-to-market, or "fair value" accounting rules, did not always reflect the substance of transactions.
"I think it was well intentioned and horribly botched," As credit markets seized last year, the mark-to-market rules forced Wall Street banks to become increasingly dependent on their valuation models to come up with figures for their hardest-to-value assets.

More Fair Value Bashing

Banking Groups Seek Suspension of `Fair Value' Rule
By Ian Katz, Bloomberg, September 22, 2008

Bank lobbying groups asked Congress and the U.S. Securities and Exchange Commission to suspend a rule that forces companies to put a price on difficult-to-value assets such as subprime mortgages. The rule ``has been a complete disaster,'' said Edward Yingling, president of the Washington-based American Bankers Association, in an interview today. ``It forced assets to be written down to fire-sale prices, which is well below what they're really worth, in a never-ending downward spiral.'' Yingling said FASB's role as the U.S. accounting rulemaker needs to be “rethought.''
Fair value “is an accounting issue that's too important to be left just to accountants,'' former SEC Chairman Harvey Pitt said in an interview today. Economists, academics and regulators from outside FASB, in addition to accountants, should be involved in considering a new approach to fair value, he said. The rule's backers say it adds to transparency and gives investors more information about publicly traded companies. "This is really just an old conflict between management, which wants to control volatility, and investors, who want transparency,'' said former FASB member Donald Young, who left the FASB in June. Companies are "blaming fair value and using the crisis for cover.'' Investors and companies would have benefited from earlier, not less, adherence to the fair-value rule, said Lynn Turner, a former SEC chief accountant. If Lehman Brothers Holdings Inc. had been quicker to write down mortgage-related assets, "the market would have forced them to quit before they got that deep into the hole,'' he said.

WSJ Blames Accounting rules for Meltdown

Why Has the Credit Crunch Been so Bad? Blame Washington.
Posted by Heidi N. Moore, September 22, 2008
Excerpt: Consider two regulatory changes that may not have started the credit crunch but amplified the effects: the move toward mark-to-market accounting and the abolition of the short-selling uptick rule. Mark-to-market accounting: This rule was officially put into place last November, though some banks adopted it earlier. As broker-dealers, Morgan Stanley and Goldman had to “mark to market,” or determine the market value of all its assets every quarter, even assets for which prices would be hard to determine. FAS 157 required all banks to mark their assets to whatever price other banks were selling similar assets. So if you were holding a mortgage security and another investment bank sells a similar mortgage security at, say, 22 cents on the dollar, you must value your mortgage securities at 22 cents on the dollar, too. Imagine that you are trying to sell a 2006 BMW. Your neighbor sells his ‘87 Taurus for $1,000. Under the mark-to-market rules, that 2006 BMW would be on your books at $1,000, too. As bank holding companies, though, Morgan Stanley and Goldman can account for their assets on a “held to maturity” basis.
Comment: The clumsy BMW vs. Taurus example above is a major stretch for anyone who has read FAS 157.

More Mark to Market Headlines

Mark to Market -- Ultimate Evil or Saviour of the Financial World?

At the AAO Weblog - The Pending Fair Value Fracas
Jack Ciesielski observes:
The current "blame the accounting" mode is like berating the UPS delivery man who brought you a pair of tan Gucci loafers instead of black ones you ordered. What did UPS have to do with faulty goods? Nothing; Gucci screwed up. What does Statement 157 have to do with crummy asset values? Nothing. Managers screwed up. It's doubtful that many critics of Statement 157 actually ever read it.

Keep Mark to Market Accounting
Where do we Go From Here, By Elizabeth MacDonald, FoxNews, September 22, 2008 9:50AM

If market watchers who know anything about accounting thought this through, they’d know to stop pressuring the accounting rule makers to suspend fair value accounting because the taxpayer is now on the hook for these assets.

Yes, governments affected by the Latin American debt crisis temporarily suspended mark to market accounting, where companies pricetagged their assets based on prevailing market prices (meaning these things were bottoming fast because no one wanted them). At that time, they let companies under their purview use historic pricing.

A Plan to Stop the Mark-to-Market Meltdown
Without Undoing the Good that Mark-to-Market
Accounting has Done
Brian S. Wesbury and Robert Stein, economists and market forecasters at First Trust make the case for suspending mark to market accounting:

And the US should avoid creating moral hazard whenever it can. But saying; “I told you that you would stay in your room for a whole week if you disobeyed, and I don’t care if the house is burning down…you are going to spend an entire week in your room,” is absurd. If we are really talking about the end of the world as we know it; who should really care about relaxing the rules for a short time to get us through.

Let’s not take this the wrong way. Mark-to-market accounting is a good thing. It makes sense most of the time, and for most financial instruments that are traded frequently, and in the open. But there are special circumstances. And today’s financial market problems would meet any definition of the word special.

And at BusinessWeek
The conversion to bank holding companies can help both Morgan Stanley and Goldman organize their assets, reports the Journal, and puts both in a much better position to be acquired, to merge or to acquire smaller companies with insured deposits. It also may allow Goldman and Morgan Stanley to avoid using of mark-to-market accounting -- which forces companies to value their assets based on the current market price.

Fair Value Takes a Pounding

Who would have thought that an accounting standard would suddenly be front and centre in the news on the current U.S. financial crisis? That's exactly what has happened with the mark-to-market rules with the Financial Accounting Standards Board (FASB) rule on Fair Value Measurements, FAS 157.

The Wall Street Journal carried a few articles on this topic this past summer, before things blew wide open last week:
http://online.wsj.com/article/SB121521130789729461.html
Bob McTeer at WSJ July 5, 2008, states that the most serious example of doing the right thing at the wrong time is overly strict adherence to the current mark to market rules. In his opinion, most of the write-downs of securities that are creating capital shortages in financial institutions don't result from actual losses, or even expected losses. They result from having to mark down assets, many or most of which could easily be held to maturity and redeemed at par. This includes securities issued or guaranteed by Fannie and Freddie and other investment-grade securities, especially those graded triple A. He acknowledges that this is a minority view, but claims the support of William Isaac, former chairman of the Federal Deposit Insurance Corporation, who says that mark to market is overdone and is pro-cyclical, since regulators limit the ability of banks to reserve during good times, but insist on increased reserves during bad times.

Getting Risk Right
By Tom Gurside and Andy Kuritzes, WSJ, July 31, 2008
http://online.wsj.com/article/SB121745359440998389.html
Direct quote from their article:"Accounting can change everything. Differences in accounting treatment of individual assets create real disparities in actual and perceived levels of risk. The shift of assets from a "held to maturity" standard to a "mark to market" basis has dramatic implications for both the timing and magnitude of losses, and has contributed significantly to the volatility of earnings in the current crisis. At the same time, accounting rules contributed to the development of the shadow banking system by allowing conduits and SIVs to be kept off balance sheets. In short, accounting matters: Firms need to integrate risk with accounting and finance, just as much as they need to integrate risk with the front office."

Now that things have blown apart on Wall St., dissatisfaction in certain circles could not be more obvious than:
In Crisis, Fingers Point at Mark-to-Market Rule
by David Reilly, WSJ, September 19, 2008

Now the demise of Wall St. firms is rekindling debate over whether so-called mark-to-market accounting has fanned the flames of the credit crisis. Before tumbling into bankruptcy, Lehmans Brothers proposed hiving off hard-hit commercial-mortgage assets so that the investment bank no longer would have to use battered market prices to value the holdings.
American International Group (AIG) contended in August that the use of market values was forcing it to recognize greater losses than it would ultimately realize on derivatives insuring complex financial instruments backed by mortgages.

Now, a major flurry of articles in the WSJ on this topic, concurrent with the $700 billion plan to save the financial markets.

Loosen Deposit Insurance Rules To Prevent a Bank Run
By Lawrence B Lindsey, WSJ, September 17, 2008
"Following Sarbanes-Oxley we gave accountants the power to use overly precise and inflexible values for assets, and compensated by allowing firms to use highly flexible and history-driven models to apply those values to test for capital adequacy.This gets it exactly wrong. Many assets are highly illiquid and the institutions that hold them, such as banks, are in the business of providing liquidity to the economy and holding such assets as collateral. Making those assets "mark to market" meant that reserves were drawn down and converted into ever more loans during the upswing, and now must be built back up at a time when asset prices are plummeting and capital is scarce. Instead, a more stable capital adequacy rule -- such as a leverage ratio that was based on the original asset values -- would limit this pro-cyclical behavior. The complex approach ...for international capital rules need(s) to be scrapped, and the process restarted."

Maybe the Banks Are Just Counting Wrong
By John Berlau, WSJ, September 20, 2008
Financial Accounting Standard 157, which U.S. regulatory agencies put into effect last November, requires accountants o look at market "inputs" from sales of similar financial assets even if there isn't an active trading market. That means that less-leveraged banks holding mortgages that haven't been impaired often have to adjust their books based on another bank's sale -- even if they plan to hold their loans to maturity. Yale finance Prof. Gary Gorton wrote in a paper presented last month at the Federal Reserve's summer symposium: "With no liquidity and no market prices, the accounting practice of 'marking-to-market' became highly problematic and resulted in massive write-downs based on fire-sale prices and estimates."These write-downs, based on accounting standards, can jeopardize balance sheets and solvency -- much like a spreading contagion. In effect, a single bank's fire sale can decrease the "regulatory capital" (or the total dollar value of assets that government regulations require banks and other financial institutions to keep as a reserve to immediately make good on their obligations to depositors and other creditors) of others. So "partly as a result of GAAP capital declines, banks are selling . . . billions of dollars of assets -- to 'clean up their balance sheets,'" notes Mr. Gorton, creating a "downward spiral of prices, marking down -- selling -- marking down again."

Other sources have contributed to the debate.
According to Todd Sullivan at Valueplays:

This is the problem with "mark to market" accounting when the market is so dislocated. It is a bit like the bank coming to you because the price of your home fell and telling you to sell your car to raise capital. If you are not selling your home and have a conforming mortgage, its current valuation is meaningless. JP Morgan does not need to sell the securities to raise capital. Now, if troubled firms desperate for cash need to dump additional assets to save themselves, the value of all assets may drop further, causing additional write-down and then the need may arise to restore ratios. What is being ignored here is the cash flows from the assets. Not all of them are impaired and now are trading at prices below the streams of income they produce.
Just because your neighbor gets himself in a jam, it should not force you to liquidate or materially markdown your assets. Mart-to-market is exacerbating the current banks problem because it is forcing actions that without it in the extremity of the current market, would not be necessary.

If you read just one article on this topic, it should be this:
All’s fair--the crisis and fair-value accounting
From The Economist print edition, Sep 18th 2008

SO CONTROVERSIAL has accounting become that even John McCain, a man not known for his interest in balance sheets, has an opinion. The Republican candidate for the American presidency thinks that "fair value" rules may be "exacerbating the credit crunch". Some fear that accounting dogma has caused a cycle of falling asset prices and forced sales that endangers financial stability. The fate of Lehman Brothers and American International Group will have strengthened their conviction.

In response America’s Financial Accounting Standards Board (FASB), and the London-based International Accounting Standards Board (IASB) have not budged an inch. So, for example, banks will have to mark their securities to the prices Lehman receives as it is liquidated. The two accounting bodies already act cheek by jowl, and America will probably soon adopt international rules. Are they guilty of obstinately pursuing an abstract goal that is causing mayhem in financial markets?

And for an in depth look at the fair value concept and rules:
Fair-Value Revolution
Historical cost accounting is fading as Corporate America marches into a new era. Davis M. Katz - CFO Magazine, September 1, 2008

The above is a really good article.

The following two well known investment pundits have weighed in:
Jeff Miller, and Jim Cramer, at RealMoney.com state that the rules should be dumped.
http://www.thestreet.com/story/10438090/1/miller-dump-the-mark-to-market-rules.html
http://www.thestreet.com/story/10438131/1/cramer-what-this-government-must-do.html

And from a former Fed staffer:
In this article,
Vincent R. Reinhart, former director of the Federal Reserve's monetary affairs division, states that:
While the reverse auctions could help banks set a clearing price for mortgage-related assets, Reinhart said, that "price doesn't mean that every financial firm will be solvent" after those assets are sold. Another risk is that if the auctions set too low a price for mortgage-related assets, other institutions with bad debt may be forced to take the distressed valuation onto their books under mark-to-market accounting rules, Reinhart said. Mark-to-market rules involve adjusting the price of an asset to reflect its current market value. "If the auctions don't go well, it will drag down everybody's balance sheet who marks to market," Reinhart said.

And finally, accounting bodies, as expected, are not about to give in:
Tweedie: Don't Blame Fair Value for the Crisis
Accounting did not exacerbate the credit crisis, says the IASB chairman.
CFO.com, September 17, 2008
Tweedie noted that "accounting is not the cause of the credit crisis, but it is important that market participants should have confidence in the information presented within financial statements."

At its meeting today, IASB will consider a comprehensive package of proposed amendments to IFRS 7, Financial Instruments: Disclosures, as part of a post-implementation review of the standard. In its discussion, IASB is expected to consider papers on disclosures related to off-balance sheet risk, fair value measurement, and financial instrument risk, including disclosures related to liquidity risk. Later this year, the board will published proposed amendments to the disclosure provisions of IFRS 7.

In addition, IASB has started work on replacing IAS 39, Financial Instruments: Recognition and Measurement. The standard is generally considered complex and difficult to understand, according to IASB. Further, it contains several alternative ways of measuring financial instruments, which can lead to reduced levels of comparability among similar companies. Up for discussion — at least until Friday (Sept. 19), when the public comment period ends — is whether IASB can reduce the number of ways of measuring the instruments.

IASB's target date for converging accounting standards with FASB, as described in the joint memorandum of understanding, has been expedited and now is set for 2011.

AIG's Fall -- the Result of Mark to Market Accounting Rules?

Excerpt from an article by Zachary Karabell, Wall Street Journal, September 18, 2008

http://online.wsj.com/article/SB122169320421449849.html

Call it the revenge of Enron. The collapse of Enron in 2002 triggered a wave of regulations, most notably Sarbanes-Oxley. Less noticed but ultimately more consequential for today were accounting rules that forced financial service companies to change the way they report the value of their assets (or liabilities). Enron valued future contracts in such a way as to vastly inflate its reported profits. In response, accounting standards were shifted by the Financial Accounting Standards Board and validated by the SEC. The new standards force companies to value or "mark" their assets according to a different set of standards and levels.

The rules are complicated and arcane; the result isn't. Beginning last year, financial companies exposed to the mortgage market began to mark down their assets, quickly and steeply. That created a chain reaction, as losses that were reported on balance sheets led to declining stock prices and lower credit ratings, forcing these companies to put aside ever larger reserves (also dictated by banking regulations) to cover those losses.

In the case of AIG, the issues are even more arcane. In February, as its balance sheet continued to sharply decline, the company issued a statement saying that it "believes that its mark-to-market unrealized losses on the super senior credit default swap portfolio ... are not indicative of the losses it may realize over time." Unless one is steeped in these issues, that statement is completely incomprehensible. Yet the inside baseball of accounting rules, regulation and markets adds up to the very comprehensible $85-billion of taxpayer money.

What AIG was saying then, and what others from Lehman to Bear Stearns to the world at large have been saying since, is that the losses showing up aren't "real." Yes, the layer upon layer of derivatives built on the foundation of mortgages is mind-boggling.

Among its many products, AIG offered insurance on derivatives built on other derivatives built on mortgages. It priced those according to computer models that no one person could have generated, not even the quantitative magicians who programmed them. And when default rates and home prices moved in ways that no model had predicted, the whole pricing structure was thrown out of whack.

The value of the underlying assets -- homes and mortgages -- declined, sometimes 10%, sometimes 20%, rarely more. That is a hit to the system, but on its own should never have led to the implosion of Wall Street. What has leveled Wall Street is that the value of the derivatives has declined to zero in some cases, at least according to what these companies are reporting.

There's something wrong with that picture:Down 20% doesn't equal down 100%. In a paralyzed environment, where few are buying and everyone is selling, a market price could well be near zero. But that is hardly the "real" price. If someone had to sell a home in Galveston, Tex., last week before Hurricane Ike, it might have sold for pennies on the dollar. Who would buy a home in the path of a hurricane? But only for those few days was that value "real."

The End of GAAP: Next Year?

The SEC suggests that some companies could forgo GAAP by the end of 2009, and that all companies may have to do the same by 2016
By Sarah Johnson and Marie Leone, CFO.com USAugust 27, 2008

The Securities and Exchange Commission has raised the possibility that some U.S. publicly traded companies will be able to use international financial reporting standards next year.

On Wednesday, the SEC commissioners proposed a timetable for transitioning all public companies from U.S. generally accepted accounting standards to IFRS within eight years, with the allowance for some companies to begin using the global rules earlier. If this so-called roadmap is approved, the SEC estimates that 110 companies would be eligible to use IFRS at the end of fiscal years ending after December 15, 2009, depending on their size and industry.

The roadmap further calls for the SEC to make a decision in 2011 regarding whether to require all of its registrants to use IFRS. The commissioners would base their decision on the progress made on, among other things, funding the International Accounting Standards Committee Foundation (which governs the International Accounting Standards Board), IFRS data tagging, and accounting education.

Before the commissioners voted unanimously to release the proposal for a 60-day comment period, SEC chairman Christopher Cox said IFRS has the potential to become a "uniter of the world's capital markets and investors everywhere." Nearly 100 countries have required or allowed their companies to prepare their financial statements using IFRS, he added.
The widespread use of the global standards and the fact that the majority of U.S. investors own foreign companies' securities "make it plain that if we do nothing and simply let these trends develop with each passing year, comparability and transparency will decrease for U.S. investors and issuers," Cox said.

David Tweedie, chairman of the International Accounting Standards Board commented: "The result of our work will be an improved set of IFRSs to assist investors throughout the world, he added.

Accounting firms, large companies, and academics have told the SEC that only a firm deadline could motivate people to get up to speed on IFRS in the United States.

These dates don't surprise D.J. Gannon, a partner at Deloitte & Touche, who said the deadlines are reasonable for U.S. companies to meet. "It is a sigh of relief in a sense because this expectation has been building since the [SEC's] concept release came out last year.... It will allow people to move forward with an actual plan," Gannon told CFO.com.

In response, large U.S. multinationals and the large accounting firms estimate that it would take U.S.-domiciled companies two to three years to make the switch to IFRS, with smaller businesses needing more time. Several multinationals have told the SEC that allowing IFRS in the U.S. would bring them efficiency and cost savings since their foreign subsidiaries are already using the global standards.

The SEC's roadmap would allow companies in about 30 industries to use IFRS early but would require them to either provide an audited GAAP reconciliation report or three years' worth of unaudited reconciliation reports. Only the top 20 companies in each industry would be eligible, based on market capitalization and whether the largest of their foreign counterparts also use IFRS.

SEC Proposed Timeline for Moving Companies to IFRS
End of 2009
Limited group of large companies given the option to use IFRS. SEC
estimates 110 U.S. companies will be able to take advantage of
the offer.
2011
SEC evaluates the progress of achieving proposed milestones,
and makes a decision about whether to mandate adoption of
IFRS. If IFRS is mandated, the commission will develop a staged
roll out, starting with the largest public companies first.
2014
Year the first wave of companies will be mandated to report
financial results using international accounting standards, if IFRS requirements are adopted in 2011.
2016
Year that all public companies, big and small, will be mandated
to report financial results using international accounting
standards, if IFRS requirements are adopted in 2011
Source: The Securities and Exchange Commission