Tuesday, September 30, 2008

Mother may I accounting...A solution

Saving private Ryan's $700 Billion - and yours too...
So going back to discretionary accounting from mark-to-market is like going back to the stone age. Well, guess what? I don't agree. Wilma!! Wilma!!! (Joke)

Suppose you do it in a very public, very temporary, very limited way and make it clear why you do it and under what conditions you will go back to it?


William Donaldson Former head of the SEC said in a Bloomberg interview that there is no CDO market, so how do you mark to it? Let's start there.

Opponents of dropping mark-to-market do not want banks to have discretion in marking paper but they want them to mark to a market that does not exist. The market they have tethered banks to is so thin with bid-offer spreads so wide that the parameters for value are elusive. So which fantasy is worse: the one foisted on banks that is bankrupting them, or the one the banks guess at looking to the future-with regulators looking over their shoulder? Chairman Bernanke admits that this mark-to-market rule results in the pricing of securities at fire-sale prices. That in turn dumps losses on banks and that sends them closer to the brink of bankruptcy. Why stick to THAT??

What is so bad about allowing relief from this so clearly failed system linked to a failed market?

Here is how to try to change it:

(1) First the proper authorities need to declare the CDO market as dysfunctional and offer accounting relief.
(2) Firms wishing such relief may petition for it.
(3) The authorities will make it clear exactly WHICH markets are dysfunctional and for those the special discretionary accounting valuation will be allowed UNTIL SUCH TIME AS THE AUTHORITY DEEMS THE MARKET TO BE WELL-FUNCTIONING AGAIN.
  • With that the market for accounting exception is well defined. Participating firms are identified. Conditions for reinstatement of the mark-to-market rule are at the same time established, making it clear that this is a temporary fix.
  • Doing this I argue would make it MORE likely that in time firms will come to see the true value in CDOs and in other mortgage products (and mortgage -related products) and real markets will develop. If banks see that other banks see long term value in this paper and if asset sales don't simply drive prices lower due to mark to market rules this approach could help to revive a real CDO market...in time.
  • The tact could be very intrusive or looser, as desired. If government were so afraid of fraud, participating firms could be required to petition for the issues they want to re-mark so a record of the security ,its current mark, its last known market value and the intended new mark would go to a clearing house. This information could be kept and analyzed in a central clearing house to compare the treatment suggested by various banks (for identical cusips) to try to keep it consistent. Authorities would have override: Mother may I? NO you may not. In this way a different set of off market valuations could be developed. Models could be used applying cash flow analysis etc to double check pricing.
  • Clearly the authorities would provide more supervision. But what I am suggesting is that it is possible.
  • I am also suggesting this can be done by having banks volunteer
  • And I am suggesting it can be DONE WITHOUT SPENDING $700 BILLION IN TAXPAYER MONEY- just some careful planning and oversight sweat of the brow. It might even create some jobs for people losing their jobs in the CDO business.
(4) Participation may still have its costs. Some of the strictures involved in the bail out bill as to CEO parachutes and even allowing for some capital participation by the government could be carried over. The plan would be optional so institutions could opt in or out.

Pandora's box stays SHUT!
All in all I think this can be made very workable and kept as loose or as tight as the authorities would want. The idea that this is opening Pandora's box is an idea for the small minded

What are you willing to try to save $700 billion?

A saving of so much could allow us to apply some the $700bln we were about to 'spend' to offer help to homeowners. So far homeowners have gotten the lion's share of the rhetoric but none of the relief! I'd suggest giving banks a 50% tax credit for the amount that they reduce mortgage amounts where mortgage value exceeds house appraisal value. In that way banks could get cushions for their write-offs and use their own market acumen as to where homeowners have a chance of surviving if their debt load is lifted and terms reset.



Avatar said...

Even the Financial Accounting Standards Board’s couldn't figure out how to deal with the mark-to-market accounting shortly after the Enron debacle. Even the Arthur Andersen accounting firm had problems with it which led to its failure too. Enron filed for bankruptcy 2001. The Financial Accounting Standards Board’s has had 7 years and they did nothing. nomedals.blogspot.com


Accounting can be complex.