How the regulatory sausage is made, mark-to-market edition

By Felix Salmon
June 3, 2009

Andrew Leonard finds a classic case of the WSJ burying a smoking gun today, in its 2,200-word investigation of the lobbying and maneuvering which caused the FASB’s abolition of mark-to-market rules. 2,100 words in, right at the very end, we find this:

Many saw the new rules as a watering down of standards. That triggered a backlash within FASB. At a meeting of a FASB advisory group in New York on April 28, three of its members threatened to resign in protest, concerned that FASB had jeopardized its credibility.

It would be helpful if the WSJ told us how big the advisory group was, to get a better idea of whether three is a big number. (If it’s this advisory committee, the answer is 13.) But in any case, when the FASB’s own advisors are threatening to resign over a change being pushed through by lobbyists and their bought-and-paid-for lawmakers, you know something pretty smelly is going on.

My feeling is that the problem wasn’t the mark-to-market accounting rules, so much as the sense in government that decisions about recapitalization, nationalization, and other forms of regulatory intervention must all be made based on FASB principles and US GAAP. If we had grown-up regulators who understood the concept of regulatory forbearance when you’re in the middle of a hurricane, there wouldn’t be any need to fiddle the books in this manner — and, for that matter, there wouldn’t have been the horrible shuttering of WaMu, either.

The whole episode is just as tawdry as the WSJ paints it to be, and is ultimately based on the weird idea that FASB rules accurately reflect reality, and that therefore if we change the rules, we must be changing the underlying reality as well. Welcome to Washington, I guess.


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I am not sure I understand this.

The lobbyists caused Congress to cause FASB to water down the MTM rules so that banks can show a profitable first quarter?
So, does that mean that the first quarter results by the banks have been boosted (at least in part) as a result of this rule change?

well, it does not hurt their chances. But it’ll largely be a reporting gimmick. The biggest change was less obvious than what WSJ covered: ability to segregate the resultant AFS/FAS115 market loss into a credit component and liquidity component. For those who know it well, the securitized markets (MBS, agency debt) had ZERO liquidity, and even now it’s in a stage of gradual improvement.

It’ll help C, for example, but a JPM or GS will show stronger earning levels (i am supposing) than previously mentioned Citigroup.

There is little defense in arguing that a non-agency MBS product is actually worth $75 when the market is currently at $40. But in real terms, that liquidity component is worth 10-20 points, and the credit component may be 5-10 points. Marking long-term assets (think an avg life of 10+ years) is a recipe for certain continued disaster, and in some form the FASB change actually allows a “gradual forebearance”… Marking losses as they actually occur as opposed to a massive loss today on loan performance TBD in next 5-10 years, while not palatable to some, allows banks to rebuild capital thru current earnings (if they exist) as opposed to forcing capital raises when private capital was absolutely scarce.

Posted by Griff | Report as abusive

My best guess would be that the committe was the Financial Crisis Advisory Group, as that was the group tasked with looking at fair value accounting in the crisis. It also has more members like central bankers and former regulators whom one might expect to object – most investors loved the change. But that committee met in London on April 20, not April 28 in New York. The official minutes don’t mention anyone threatening to resign (I wouldnt’ expect them to), but they do show there was a vigorous debate over fair value measurement.

None of the other committees listed by FASB had meetings on April 28.

Posted by Ginger Yellow | Report as abusive

I would tend to agree with Griff. The WSJ article seemed to make lots of hay out of FAS 157 changes but for the most part banks had already been using those kinds of techniques. Bob Herz (FASB head) has always said that MTM was never a “last trade” model but that it had evolved into it when auditors couldn’t come up with anything better.

It’s true that the OTTI/115 change could make earnings look better but since the non-credit (liquidity) component of the mark will still flow into OCI, it still impacts capital levels.

All in all, I think the changes they made were really minor. There are still trading, AFS/HFS and HTM/HFI categories and they will still be marked appropriately.

Posted by Butters | Report as abusive