Accounting change won’t save banking

By J Saft
March 13, 2009

James Saft Great Debate —James Saft is a Reuters columnist. The opinions expressed are his own. –

By all means reform accounting, but for pity’s sake take your time and keep your expectations low.

Suspending mark-to-market accounting immediately as a means of levitating banks out of peril simply won’t work. While transparency may or may not be the foundation of banking, trust undoubtedly is.

“Adjusting” or suspending fair value accounting, even if you swear up and down that this time it’s even more fair will erode rather than build trust and repel rather than attract capital.

The House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, led by Congressman Paul Kanjorski of Pennsylvania today is holding a hearing on mark-to-market and already the industry knives are out.

A group of 31 industry groups and financial institutions, including the American Bankers Association, Mortgage Bankers Association and U.S. Chamber of Commerce, have petitioned the committee to take “immediate action” to stop the “spiral of accounting-driven financial losses,” according to the Los Angeles Times.

They argue that current rules, which force banks to carry some securities on their books at levels that reflect current market prices, mean they have to recognize losses that “do not have a basis in economic reality”.

That’s as may be, but so far market prices have arguably been a better directional indicator of the future performance of collateral than some hopeful internally generated marks. Is mark-to-market perfect? No. Might reform, in the fullness of time, adjust some of its pro-cyclical effects? Yes. Will doing that in the midst of a crisis have the desired effect? No.

This whole effort fundamentally misunderstands the situation facing banking.

The problem facing the banking industry is not just solvency on some accounting or regulatory basis, it is solvency on, for want of a better phrase, a solvency basis. Thus banks are unwilling to do business with one another and investors unwilling to lend banks money or invest in them. They do not reliably know who is bust and who is not.

Some may possibly be tarred unfairly by mark-to-market, but allowing everyone to step back from market discipline will make investors less willing to commit capital to banks and banks less willing to do business with one another.

Regulators and accountants may turn a blind eye, but given the current set of economic circumstances people with money on the line won’t find internally generated prices for assets more inspiring of confidence than market derived ones. Quite the opposite.

– At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund –

64 comments

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The idea that banks can scrap the discipline of ‘mark to market’ is insane and poses a clear and present danger not only to the financial system but also to the broader economies- it is precisely because the banks lost their collective grip on reality that we find ourselves in the situation that we are in- allowing them to effectively ‘self certify’ the market values of their toxic paper will end in compounded disaster on an unimaginable scale- any trader can tell you that as soon as you cease marking to market you are denying the reality to yourself of your trades and your P&L. Such a collective irresponsible action would elevate the calumny of the banking community to new heights that would create dangerous precedents. We would be complicitly indulging in inflating the world of financial make believe to unprecendented boundaries to our peril.

Posted by Andrew Marks | Report as abusive

“They do not reliably know who is bust and who is not.”
——————————————————–
Hhm, but maybe they do know that they are all bust?

Posted by Robynne | Report as abusive

“people with money on the line won’t find internally generated prices for assets more inspiring of confidence than market derived ones. Quite the opposite”

“Will doing that in the midst of a crisis have the desired effect? No”

Good point.

Posted by Arun | Report as abusive

Blaming mark-to-marked for their problems is a diversion by the financial industry. The problem is the excessive and reckless leverage taken on by the irresponible and border line criminal management that stuffed their pockets with profits when the market was going up, but now that everything collapsed the institutions that they “managed” are wiped out and what do they blame? Some accounting standard which is actually correct. If they are so adamant that their “assets” have “value” they should be able to find a buyer. Who needs real estate on the Moon? Nobody, but it arguably has value too.

Posted by Sam | Report as abusive

One consistently sane voice in the midst of confusion, deceit and utter stupidity.
Keep up the good work

Posted by Nikos | Report as abusive

the problem with trust now is that the mtm gains were consumed, and for the mtm losses now, can the committee defer it?

Posted by NAB | Report as abusive

I think creative accounting practices put us into the present banking situation. I am sure changing to creative evaluations practices will make the whole situation worse. James, blaming accounting for financial losses is like blaming the referee because your team played poorly for a season.
Now, your team is going to play better if the referee looks the other way?
I fully agree covering up the true value of assets will not make things better keep up the good work.

Posted by Craig Coal | Report as abusive

It’s a little surprising to hear bankers complain about accounting rules. They can’t exist without them. Money is the biggest work of art of all.

We all want to believe that what we hold as assets are worth more than reality is sometimes willing to pay for them. If no one can buy what you want to sell than those assets have a lower value. No one can argue with that. The bankers may want to argue that they know what they hold is more valuable than the market at the time can support but if everyone believed that all the time, there would be no variation in stock prices on the exchanges.

Bankers and stock traders live on that fundamental vagueness of value often to their advantage.

In the modern economy, assets have only book keeping value. A particularly cruel illustration can be drawn from the property in low-income neighborhoods especially during the days of red lining (and many bankers would bring them back if they could). Property that could be nearly identical to property in neighborhoods not red lined could be worth far less because no one with higher incomes was willing to invest in them nor could those living in them ever get sufficient capital to repair or improve them.

Another example can be drawn from the turn of the last century in Newport, RI and Fifth Avenue in New York. The introduction of the income tax left countless very high quality mansions and town houses fit for nothing but the wreckers. The millions (they would have cost mega millions today to reproduce) were reduced to splinters and rubble within a decade. Some were destroyed before the plaster was dry.

Assets have no inherent value – they are dependent on what others think they are worth or can afford. Right now bankers sit on a stock of housing in about the same way as one’s neighbors sit at the tables at their weekend garage sales.

But I agree with Mr. Saft that really what they need is very reliable accounting rules that somehow make the abstraction of money as consistent and commonly understood as one’s native tongue. So much of the problem with the economy now is that they were using terminology and accounting “inventions” and practices that many of them didn’t understand either.

They were trying to speak Esperanto when every one was still thinking in English – so to speak.

What they need also is a set of accounting rules that are not state based but uniform across borders. That is highly unlikely. The Chinese know that with sufficent control the state can dictate “value”.

Posted by Paul Rosa | Report as abusive

Can’t we simply replace high flyin’ bankers with some ghetto drug dealers? They know their accounting, their business and they don’t believe in credit…they just might do a better job.

Posted by Dan | Report as abusive

If no one will buy my asset yet it reliably generates a cash flow, does that make it worthless? Mark to market would say yes. The problem with much of these unmarketable assets is their “mystery meat” quality. Disclosure of their true identity would go a long way towards establishing a reasonable value with or without impairment on the balance sheet. If identification is impossible then there is likely no market for such a grab bag and a value of zero, or close it it, seems warranted.

Posted by Barry Northrop | Report as abusive

Blaming accounting rules for the banks’ current state is like shooting the doctor that tells me I’ve got cancer. Accounting rules are devised to provide as accurate and objective information as possible regarding the status of an entity. True, they are not perfect but that is true of so many other things like assuming that markets would regulate themselves and get us out of harm’s way (which did not happen)
What amazes me is that the same people that profited from using the markets as sources of seemingly endless gains now shun the markets’ very same messasge. After all, what the accounting rule says is take market values in appraising assets so in ignoring the rule they’re shunning the very market they so passionately defended earlier.
In the end, the question boils down to what constitutes “real” change. I would argue that whenever an economic event impacts an individual’s decisions on spending, saving, and working, those should be considered as real events. For instance, if an individual sees that his house is worth more and consequently saves less/spends more/ works less then such event should be acknowledged. Likewise (and we are seeing this nowadays) when individual see the value of their assets sink and spend less/save more/(attempt to) work more then such value loss is “real”
So, if banks find out that its assets being worth more change banks and investors’ behavior -the former are less willing to borrow and lend, and the latter find unattractive to own bank assets- such event is real and must be acknowledged. All other discussion is nonsense

Posted by ecogabriel | Report as abusive

Intelligent investors will never mistake a pigs ear for a silk purse no matter what happens to the accounting rules. Any changes will just make us even more distrustful of the regulators and the bankers

Posted by anton kleinschmidt | Report as abusive

Not being a banker or an economist, this sort of discussion is a bit over my head. But I read Mr. Saft anyway because it is helpful in understanding the current panic.

On the same Reuters page the headline article was the concern from the Chinese about their holdings regarding deficit spending. I’ve often wondered when they will simply take us over in what wil be the most bloodless and softest takeover ever seen.

And your contributor who wrote about drug dealers running the financial scene is bizaare and very interesting. It would make a good movie project, and very au courant. I am a Producer and a Performer for 40 years and I can smell interesting material.

Forgive me for not commenting on your good work. I read you consistently. All the best.

Posted by Andrew Franks | Report as abusive

It is important to note that the losses will still have to be recongnized under cost accounting aswell as fair value accounting. Even if mark-to-market accounting is being suspended, losses are still recognized.

Posted by Dario | Report as abusive

When I was working briefly for a lender, I asked about the accounts that never seemed to get paid and whether it was practice to write down the values. I was told that in practice they just kept refinancing the accounts to make them appear up-to-date and paid up on the books. So the bad assets never get written off. The operations and assets of the lender were later purchased by a Canadian bank. I hate to say it, but the books can be made to say anything. Do you want a steady income stream? No problem. Or maybe choppy growth would be more realistic. Fine, anything is possible.

Posted by Don | Report as abusive

Months and months go by; assets go unsold. Banks seem to be in need of good, hard working, honest salesmen. They should be able to find the cost/benefit of things of value.

In the 1930s, T. J. Watson, IBM founder, was asked by friends , ‘Why are you hiring? Don’t you know we are in a depression?’ He quipped, ‘Some men drink. Others gamble. I hire salesmen.’

(single quote marks used to indicate I quote only the jest of what was said, if you want an exact quote, look in quotation books)

Posted by skinner | Report as abusive

I think Don has it right. In an essentially corrupt system, anything is possible. Our respect for law was flushed when the top leadership not only expressed contempt for the Constitution (“just a piece of paper”) but actually engaged in crimes against humanity without impeachment while handing their corrupt corporate pals no-bid contracts to get the job done. When the top leadership is corrupt, you get the real trickle down economics. Call it trickle down corruption.

Posted by Jonathan Cole | Report as abusive

Spot on.

Note that while it might make sense as you suggest to reach, in time, some accommodation in accounting rules where mark to market was allowed some latitude for extraordinary market conditions, very nearly all see through the banker’s charming little dance of the innumerable veils slowly revealing yet concealing the presumed horrors beneath.

Note, too, that this push on their part coincides with a week of extraordinary positive spin to reassure markets, which spin has proven sufficient to produce a thus-far-comfy bear rally.

Wouldn’t it be bizarre if some part of the political/financial establishment attempted to truly confron the extent of the crisis?

Let’s all hold our collective breath and wait for that to happen.

Posted by Big Al | Report as abusive

Mark-to-market has been around quite long. No problem. Suddenly a gang of financial and big biz elites want it suspended, or stop. Because they want to keep their fake assets on the books. These assets are created by them to be fake, market then mark them to be fake. They even refuse to trade the fakes between them.

And now they want the government to change the accounting rules to fake the fakes. After what these guys have done to the economy.

The audacity of the mafia mindset is infinite.

Change the MTM rules the the following WILL happen: Absolutely nobody in the world will place one iota of credibility on the SEC and the financial institutions. Obama might as well shut down these guys and start all over.

Posted by TomK | Report as abusive

Here’s Cassandra again

Posted by Luca | Report as abusive