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Truth or Consequences
In response to my article last week on a possible return to mark-to-market accounting standards, I had a couple of dear readers write in with contrary views.
One dear reader backed up his views by sharing the words from no less a dignitary than Bob McTeer, a former president of the Federal Reserve Bank of Dallas, who wrote in favor of scrapping mark-to-market and, for good measure, weighed in with fawning support for the efforts of Fed Chairman Ben Bernanke.
Another dear reader wrote in to say that we were communists for suggesting mark-to-market accounting made sense. If I understood the gist of his ramblings correctly, we were communists because honestly accounting for the toxic garbage on banks’ balance sheets would cause a collapse of many of these institutions – the exact sort of ploy that communists would champion.
While we may be many things, we don’t think being communists is one of them. And excuse me if I fail to bow humbly in the face of arguments by an esteemed Fed insider.
Even if I had any inclinations to accept authority blindly, which I don’t, all that’s needed to dismiss pretty much anything McTeer or anyone else from the Fed has to say is to glance even casually at the collapsing purchasing power of the dollar since the Fed was founded in 1913.
Time being short, I just grabbed the following chart, which, while not up to date, paints a clear picture: the Fed has failed miserably at protecting the currency, purportedly its primary purpose.
As for a potential return to mark-to-market as the accounting standard of the day – and the negative impact that could have on banks and other institutions now buried in toxic waste – the only alternative is to allow these institutions to continue with the fiction that the assets now on their books are good. Using the historical pricing method, which is what replaced mark-to-market thanks to the pressure put on the FASB, a bank can use the cost basis of a bond as proof of a historical valuation, even though the underlying assets supporting those bonds have been blown to pieces.
The fallacy of that approach can be quickly seen by a glance at the news…
Muni bonds lose ratings after Ambac junked. (From the Financial Times, July 31)
Thousands of municipal bonds have lost their ratings and others have been downgraded after Standard & Poor’s this week stripped bond insurer Ambac Assurance of its investment-grade ratings… As of March 31, Ambac guaranteed $232bn of muni debt.
S&P this week cut Ambac’s ratings to double C from triple B after its parent company Ambac Financial warned that it would report a $2.4bn loss on credit derivatives contracts that would put it at risk of violating minimum capital levels required by regulators.
“You may wind up with a generation of muni bonds with semi-permanent illiquidity,” Mr Fabian (managing director at Municipal Market Advisors ) said.
Derivatives: A Closer Look at What New Disclosures in the U.S. Reveal (Fitch Ratings, Special Report, July 22)
Fitch Ratings reviewed the quarterly filings of 100 companies from a range of industries representing nearly $6.4 trillion in aggregate outstanding debt. The 100 companies reviewed were those with the highest levels of total outstanding debt in the S&P 1,500 universe; they represent approximately 75% of the total debt of S&P 1,500 companies. The companies reviewed had a total notional amount of derivative positions in excess of $296 trillion and a net fair value in excess of $240 billion.
… an overwhelming majority (approximately 80%) of the derivative assets and liabilities carried on the balance sheets of the companies reviewed were primarily concentrated in five financial services firms: JPMorgan Chase & Co. (JPMorgan); Bank of America Corp. (Bank of America); Goldman Sachs Group Inc. (Goldman Sachs); Citigroup, Inc. (Citigroup); and Morgan Stanley (Morgan Stanley)."
Our own Bud Conrad weighs in…
So far the regulators have done nothing to force the firms in question to address these risks. If subprime housing looked like a boulder balanced on a fence, this looks like a nuclear arsenal.
MBIA tops one list of derivatives compared to liabilities, but the big banks and AIG are the big holders.
This is only one reason why McTeer doesn’t think marking to market was such a good idea.
And here’s another…
While we have seen some modest clawback in house prices – a temporary phenomenon due to the advent of the seasonal selling season that will dissipate over the next couple of months – there is no ignoring the fact that prices remain far, far below where they were at the bubble top. Yet, banks across the country still carry mortgages and securities backed by mortgages on the books, as if there had been no meltdown in housing prices.
So, what’s it going to be: fact or fiction? Yes, if the reborn FASB (no doubt a bunch of commies) gets its way and we see a return to mark-to-market, it has the potential to unleash a dark retribution on paper tiger banks. But what’s the alternative? Continue the charade, sucking unwitting investors into the stocks and bonds of institutions that are for all intents and purposes deeply undercapitalized, if not outright bankrupt?
Watch the progress of the mark-to-market debate closely. If the truth wins out, there will be consequences. |
