STOP BEGGING BEN FOR HELP COOKING BANKS' BOOKS, by Jonathan Weil -- The Catbird's Forum

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Date Posted: 03:06:14 04/30/08 Wed
Author: Poster child
Subject:

STOP BEGGING BEN FOR HELP COOKING BANKS' BOOKS, by Jonathan Weil

Stop Begging Ben for Help Cooking Banks' Books: Jonathan Weil

Commentary by Jonathan Weil

April 30 (Bloomberg) -- Orange County, California, gave us much of the mortgage mess. Now one of its local congressmen is seeking new ways to keep us from knowing how bad it is.

Meet U.S. Representative Gary Miller, a real-estate developer by trade, whose home county once included five of the nation's 10 largest subprime home lenders. Last week, Miller succeeded in getting a little-noticed amendment attached to a bill aimed at helping struggling homeowners refinance their mortgages. The insert would require the Federal Reserve to ``study'' the Financial Accounting Standards Board's rules on mark-to-market accounting and report back to Congress.

Without these rules, we might never have known so many banks had such big holes in their balance sheets. What Miller really means by the word ``study,'' though, is this: ``Dear Ben, tell us how we can gut the rules.''

Miller's amendment would require the Fed, led by Chairman Ben Bernanke, to examine ``the feasibility of modifications of such standards ... during periods of market fluctuation.'' The goal would be to let lenders ``continue to carry mortgages on residential property at risk of foreclosure and assure the availability of credit to refinance at-risk residential mortgages.''

In other words, let's see if we can get banks to lend more money by letting them show more capital than they actually have.

Miller's press secretary, Scott Toussaint, confirmed the Republican lawmaker dislikes the FASB's rules. ``In today's economy, mark-to-market accounting causes many asset values to be understated, write-offs to be overstated, and the credit crisis to be exaggerated,'' he says. ``The volatility in the marketplace may not be indicative of the banks' true financial condition.''

If banks really are overstating their losses, though, then they're not marking to market. They're marking to something else. As for volatility, it is the reality of today's economy. What investors don't know can kill them. Just ask Bear Stearns Cos.

Perhaps there is a silver lining here. Maybe if the Fed did study the rules, it would realize their true shortcoming: The problem with mark-to-market, or fair-value, accounting is that there isn't enough of it. Here are some ways to fix that.

Fix No. 1: Treat all securities the same.

The accounting rules now let companies classify securities on their books as trading, available-for-sale, or held-to- maturity. That creates needless complexity.

Unrealized gains and losses on trading and available-for- sale securities are marked at fair value each quarter on the balance sheet. Changes in trading securities get included in quarterly earnings. Yet changes in available-for-sale securities don't, as long as any losses are deemed temporary. Roughly defined, the word ``temporary'' means the company's chief executive hasn't been fired yet.

Meanwhile, held-to-maturity securities stay on the balance sheet at cost, except for ``other-than-temporary'' losses. So, the same kind of asset can be treated three different ways, depending on what the owner supposedly intends to do with it.

``All forms of intent-based accounting are problematic, as intent does not change the risk or value of a position while you hold it,'' says Stephen Ryan, an accounting professor at New York University.

The FASB should end this. Treat all securities the same, and count all changes in quarterly earnings. While we're at it, do the same for loans on lenders' balance sheets, and get rid of the multiple classifications for them, too.

Fix No. 2: Stop smoothing earnings.

Where do those unrealized gains and losses on available-for- sale securities go? Rather than hitting earnings immediately, they get dumped into a holding tank on the balance sheet called accumulated other comprehensive income, or AOCI, where they may sit for years before getting released into net income.

Changes in derivatives labeled as ``cash-flow hedges'' also cycle through AOCI. Other derivatives don't get this special earnings treatment.

Freddie Mac, for instance, at Dec. 31 had $11.1 billion of net losses sitting in AOCI. That figure reflects real economic destruction. It should be included in earnings now.

Fix No. 3: End elective fair-value accounting.

Last year, the FASB issued a new standard called Statement 159 that lets companies pick and choose which financial assets and liabilities to measure at fair value on a recurring basis, in instances where fair-value reporting isn't mandatory.

So, some companies now apply fair-value accounting to certain kinds of debt, while others don't. Or they may carry various types of insurance contracts or loans at fair value that competitors don't. Etcetera. It's legalized cherry-picking, and makes comparing one company to another impossible.

If fair values for a given class of assets or liabilities are reliable enough to let one company use, then everyone should have to use them.

Fix No. 4: Faster disclosure.

Thanks to new rules called Statement 157, all companies this year will be disclosing quarterly changes in their hardest-to- value financial instruments, known as ``Level 3'' assets and liabilities. For instance, net unrealized Level 3 gains at Goldman Sachs Group Inc. were $2.07 billion last quarter, or 96 percent of its pretax profit.

The problem is that companies don't have to disclose information about their Level 3 holdings until their quarterly financial filings. So investors reading Goldman's latest earnings press release didn't have a clue. Investors shouldn't have to wait. The Securities and Exchange Commission should require this information in earnings releases, too.

Such changes may not be what struggling banks want. They would, however, help investors reach more-informed decisions.

Please, though, keep Congress and the Fed out of it. They've done enough damage already.

(Jonathan Weil is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Jonathan Weil in Boulder, Colorado, at jweil6@bloomberg.net

Last Updated: April 30, 2008 04:08 EDT

http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_weil&sid=aRFzA5qJQyd8#

Also see:

http://www.kycbs.net/CITIGROUP.htm
http://www.kycbs.net/Bear-Stearns.htm
http://www.kycbs.net/Bank-of-New-York.htm

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