The Financial Accounting Standards Board succumbed today to intense pressure from the banking industry and Congress, by relaxing the rules surrounding mark to market accounting. These were already loose rules to begin with. Banks could use internal models rather than an outside price to determine the value of an asset. They had great flexibility on what went into this “mark to model” pricing.
That wasn’t enough, though, Certain assets like mortgage-backed securities had outside prices, but for the longest time these have been anywhere from 30 cents/dollar down to nearly zero. A small number of trades were being down at these greatly-reduced prices. The banks argued that their much large portfolio of trades, if forced on to the market at once, would drive even these low prices close to zero. Also, the assets over their shelf life of five to ten years will generate enough cash flow to justify much higher prices today – more like 60 cents to 70 cents on the dollar, the price which the bank was currently using for valuation.
The FASB said in situations where the market price was not orderly, or where the bank is forced to sell the asset for regulatory purposes, or where the seller is close to bankruptcy (that means Citigroup), the bank can ignore the market price and make up one of its own.
Here’s one thing you may want to remember about all this. Prior to 2007, you never heard about mark to market or mark to model pricing. No one in the banking industry was screaming for accounting relief, and Congress wasn’t hauling up the FASB to pressure for changes. That’s because even though the market price for a lot of these securities was coming from disorderly, thin, and dysfunctional markets, prices were going up. Every notch higher in prices for these securities and derivatives, even if the market price was overinflated and the transactions behind them were corrupt, meant more profit and bonuses for the banks.
The banking industry has pressured and now succeeded in having it both ways. It can draw all the benefits of mark to market pricing when the markets are heading higher, and it can abandon this discipline when the markets go down (and trading assets will now magically turn to investments in down markets). These accounting standards say that you cannot trust the financial statements of the large banks, since they have now been given gigantic latitude to fudge the books.
On the Great Seal of the United States the bald eagle holds a quiver of arrows in one claw and an olive branch in the other. I suggest both these be replaced by the newest, more appropriate symbol of America – bananas. That’s the sort of Republic we’ve become.