Wednesday, 09 February 2011 06:46

FASB Appears to Have Bent Over For The Final Time & Accuracy In Financial Reporting Dies An Ignominious Death!!!

This is my response to an inciteful insightful comment posted by GJK313. It is in reference to an article which readers can find here, titled "FASB Surrenders - America Win". I suggest readers read the aforelinked document in its entirety before moving on. Notice how this is written by economists and analysts, not real world investors that are investing THEIR OWN CAPITAL! When I state "own capital" I mean their money, and not that of their clients. I cannot fathom how anyone who had their own money at stake would ever want more ambiguity in pricing assets, in lieu of less.. Let me pick this apart...

"Somehow it believes that marking everything to market (even when that market is illiquid) will somehow make the world a better and safer place"
Well, when the market is illiquid, the assets in said market have a lower market value. It really is that simple.
"Somehow it believes that marking everything to market (even when that market is illiquid) will somehow make the world a better and safer place"
Yes, because if said banks had to liquidate their loans the only place to liquidate them would be said "illiquid" market. This goes to show you how the value of the loans are probably highly overstated by those such as the authors of this article. Guarantee me that no bank will ever go bust again - guarantee me that no bank will never, ever need to sell assets, and I will soften my stance some on mark to market accounting. Until then...
"banks will be allowed to carry loans on their books at amortized cost, reflecting cash flow (payments), as well as reasonable estimates of likely loan losses."
This should now mean that the price of all unsecured loans should drop immediately and dramatically for all consumers, for FASB and these authors are not differentiating between loans backed by collateral and loans not backed by collateral. Many formerly overcollateralized real estate loans are now partially or fully unsecured due to the collapse of real estate "Values" and "Prices" (yes, there is a difference). They are also not taking into consideration the financial and strategic advantages of defaulting on a loan against an asset with negative equity. So, if the banks can now benefit from pricing loans at will (as the authors stated, "reasonable estimates of likely loan losses" - who will make these estimates?), regardless of collateral, why shouldn't that benefit be passed onto the consumer and allow them to enjoy said valuation/pricing perks. Picture me going to a bank and saying, "Just loan me $4 million with nothing hard to back it for no more than you charge that guy with a 40% overcollateralized loan. You can't charge me more since I will keep my payments current and you will be able to make a "reasonable estimate" of the losses, of which of course there will be none because.... Well, just because!"
Does this scenario make any sense to you?
"Like the sword of Damacles, mark-to-market accounting has been hanging over the head of the economy. As long as it could be broadened, or brought back in the form it took in 2008, the risk of turning the next recession into a panic or even a depression was very real."
Nonsense and rubbish. If mark to market would have been implemented faithfully, the last crash would not have been asset based for the bank/developer/investor assets would have had the clarity of valuation that would have prevented the FUD (fear, uncertainty, and doubt) that surprised the banks (and their investors/insurers/stakeholders) and caused them to collapse in mid air. Notice how absolutely NO ONE was complaining about M2M between 2003 and 2007 when asset prices were flying through the roof! When the market started turning, banks wanted to keep their marks at the elevated BUBBLE prices and actually won the right to do so through regulatory capture - see About the Politically Malleable FASB, Paid for Politicians, and Mark to Myth Accounting Rules. The US banking system is now built upon one giant LIE! Reference More on Lehman Brothers Dies While Getting Away with Murder: Introducing Regulatory Capture.

"According to Milton Friedman (in his book The Great Contraction), fair value accounting was the predominant force for bank closures in the early stages of the Depression. These bank failures fed on themselves making the Depression worse."
Oh, okay. It's good to learn that. I thought it was irrational exuberance, greed, and a run up of prices unfounded by the fundamentals.
"There is absolutely no academic research on the role of MTM accounting in the Great Depression"
'Nuff said! The authors seem to be either be lacking in credibility due to an obvious agenda or incapable of seeing the facts. Check this out...
"Nothing has changed. Back in 2009, Congress passed the Dodd-Frank financial regulation bill based on a flimsy theory of the crisis’s causes even before the report from The Financial Crisis Inquiry Commission. But that report would not have changed much policy anyway. On January 24, 2011 – the same week as FASB’s surrender – the FCIC said that the debacle was caused by a combination of stupid and unscrupulous business practices mixed with lax oversight by regulators. No surprise there"
Well, if M2M was adhered to and enforced, those business practices labeled as stupid would not have been profitable hence would not have been pursued - if pursued would have resulted in said institutions going out of business BEFORE they destroyed the economy! If banks were forced to retain the risk of loans that were written and that risk was regularly and accurate marked to market, any "stupid and unscrupulous business practices" would have resulted in the market putting said operations out of business and thus there would not have been as much of an effect from "lax oversight by regulators". You see, it really is that simple. I was able to witness much of this foolishness first hand as an investor. The only reason the banks through out money the way they did was because it wasn't their money they were throwing out, it was their naive investor's monies. Investors who didn't believe in ardent marking to market, obviously. If the collateral was properly vetted and marked, and the banks were forced to retain sizable risk, the pain would have been to great to push the bubble to anywhere near the heights it attained. Any institution that would have tried either would not have had access to the funding at a profitable rate, or would have simply been pushed out of business. Let the market work, don't just let it work when the prices are going up.

"It was on March 9, 2009 that Barney Frank’s committee announced a hearing on fair value accounting. FASB was brought to the table and forced to correct its misguided rule"
This says it all. Politicians are forcing accountants to do things their way. After all, how in the hell will accountants know as much about accounting as professional politicians such as Barney Frank do???!!!
"The stock market bottomed on that day and has virtually doubled since then. The recession was not ended by stimulus, TARP, regulations, PPIP, or any of the other alphabet soup government programs. It was ended by the correction of mark-to-market accounting. The risk of another Depression ended on that day and the economy and market have done nothing but move higher ever since."
Actually, the guarantee of reality catching up with the fantasy that was codified into regulation has been firmly entrenched. The authors are making the same error that many ivory tower and investors lacking in objectivity make, and that is assuming that the market prices necessarily and accurately reflect value. This is also a circular argument, because if the authors really had that much faith in the movement of the markets, why in the world would they argue against the markets pricing bank assets??? Again, and you will see this often, many pundits believe the market is right when it is going up, but it is dead wrong when it is going down. The Fed, Barney Frank, et. al., and the Treasury colluded to lift the prices of equities, real assets. government bonds, and the derivatives based upon them to considerably above their fundamental values in an attempt to reflate the bubble and pull the country out of recession the "stanky" way.
A natural result of this is that banks can easily hide the true condition of their holdings from most investors. Reference The Financial Times Vindicates BoomBustBlog’s Stance On Goldman Sachs – Once Again! wherein I detailed this occurrence:

 

 

fasb_mark_to_market_chart.png

I declared insolvency throughout the banking system, and it looked as if I was wrong for some time, then the truth’s ugly head started peaking out. See The Financial Times Vindicates BoomBustBlog’s Stance On Goldman Sachs – Once Again!

Goldman Sachs has revealed details of about $5bn in investment losses suffered during the crisis for the first time this week, in a move that will deepen the debate over companies’ financial disclosures. The figures, issued as part of internal reforms aimed at silencing Goldman’s critics, show that the bank suffered $13.5bn in losses from “investing and lending” with its own funds in 2008. But Goldman’s regulatory filings and its executives’ comments to investors at the time pointed to about $8.5bn of losses arising from its investments in debt and equity, as markets were rocked by the turmoil.

Hmmmm! I walked through this in explicit detail in “When the Patina Fades… The Rise and Fall of Goldman Sachs??? and I did it without being privvy to Goldman’s financial innards. Long story short, practically all of the major banks are lying about the value of some of the largest assets on their books.

How many institutional and/or retail investors will be able to ferret out such? Or more importantly, why should they have to? It is the reporting company's responsibility to report, not to obfuscate.

 

 

The big problem with this "hide the market marks" thing is that markets tend to revert to mean. Unless said market values fundamentally catch up with said market prices, you will get a snapback. That is what is happening in residential real estate now. That is what happened in Japan over the last 21 years!!! That's right, it wasn't a lost decade in Japan, it was a lost 2.1 decades!
This has been the first balance sheet recession that the US has ever had, but there is precedence to follow. Japan had a balance sheet recession following their gigantic real asset bust. They made a slew of fiscal and policy errors, which essentially prolonged their real asset recession (now officially a depression) for T-W-E-N-T-Y  O-N-E long years! For those that may have  a problem reading that, it is 21 long years. What did the Japanese do wrong?
  • They refused to mark assets to market
  • They attempted to prop up zombie banks
  • They failed to promptly clean up NPAs in the banking system
  • They looked the other way in regards to real estate value shenanigans

What was the result? Let's reference Bad CRE, Rotten Home Loans, and the End of US Banking Prominence?

 

 

Now, for those of you who believe that the government's "pretend and extend" policy has any chance in hell of working, or better yet, that we are not following in the footsteps of Japan, let's take a pictorial trip through recent history. There are nearly no Japanese banks in the top 20 bank category on a global basis by 2003 – NONE (save potentially Nomura, which arguably survived in name, alone). As you can see, they literally dominated 90% of the space in 1990!

Click to enlarge…

top_20_banks.jpg

Source: Cap Gemini Banking M&A

 

 

Now, cross reference this chart with the graph immediately above it paying very close attention to the respective years in question. I should be able to stop this post at this point, for if you haven't gotten the message by now - you just ain't gonna get it.
"With FASB finally giving in on the issue for good, the future looks a lot brighter than most people suspect. The accounting rule fell, it has been ignored by most, but the impact of that fall is very good for America."
Well, its good for those astute and capable individual investors who can parse balance sheets and value assets on their own. Its an insult, slap in the face, and condemnation to a perpetual guessing game, Ponzi scheme and virtual casino for the average individual and institutional investor. Unless we want to read about this for practically all financial institutions that you risk putting your life savings in...
Goldman Sachs has revealed details of about $5bn in investment losses suffered during the crisis for the first time this week, in a move that will deepen the debate over companies’ financial disclosures. The figures, issued as part of internal reforms aimed at silencing Goldman’s critics, show that the bank suffered $13.5bn in losses from “investing and lending” with its own funds in 2008. But Goldman’s regulatory filings and its executives’ comments to investors at the time pointed to about $8.5bn of losses arising from its investments in debt and equity, as markets were rocked by the turmoil.
Last modified on Thursday, 14 July 2011 05:28

13 comments

  • Comment Link gjk313 Friday, 11 February 2011 22:26 posted by gjk313

    So, you know accounting does not matter any more which means we can mark our book to whatever we want...well you know, it's all starting to make sense to me now. I look at some of the valuations of certain stocks in the market and it really begins to remind me of 1999. Here are 2 examples: BIDU @ 36x P/S ratio and APKT @ 20x P/S. Does anyone know of any others that may be higher?

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  • Comment Link Jim Friday, 11 February 2011 09:22 posted by Jim

    Actually, when two indicators that are calculated along different lines converge, such as the slope of your graph and the calculations you made last summer on overhang, then the predictive value of something like that graph goes up greatly. Unlike Spain, a financier who loses his job on Wall Street today can be working and buying a house in Minneapolis next week. I agree wholeheartedly that interest rates can only rise - and already are on the long end, and in mortgages. However, mortgage rates will have to hit 6%, before a person with a job really feels it. The average joe with a job deals with cash flow and now is looking at real affordability in many markets. The rise in cash deals around the country over the past year or two seems to indicate that many are ready to invest in the rental market, which is amazingly firm considering the financial climate. The zero interest rates policy could keep mortgages affordable for the next two years, which is key, because so many junk mortgages were written on a 5-year ARM between 2005-2007. ZIRP may just keep banks afloat until they work through the cresting wave of junk in 2012. In the meantime, suffering will be highly uneven.

    It looks like a classic case of economic substitution, where many of those afflicted with mortgages they now cannot afford have quickly moved into a rental market they can afford, especially for houses. As a condo owner, this hardly cheers me up, because I foresee condo overhang lasting a lot longer than that of houses, especially in the SW and SE. Baltimore is anemic, and DC condos are way overbuilt. As you deduce, Morgan Stanley likely is not long for this world, and more big construction firms are going to have to throw ballast and/or disappear. This Great Recession looks not so much like the Depression or Japan as a super-sized version of 1979-83, when companies fired older and less productive workers and radically realigned their operations with new technologies and strategies. Much of the future, therefore, will depend on how the federal government deals with the growing wave of Social Security and Medicare recipients.

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  • Comment Link Reggie Middleton Friday, 11 February 2011 02:41 posted by Reggie Middleton

    "The slope of the US line as of the end of 2010 is much steeper than your extension of it. In fact, the current slope looks to hit bottom about 2018, where your chart of property overhang from 2010 predicts the property bubble finally will shrivel."

    The problem is that prediction, like most, is compete conjecture. Mathematical slopes are notoriously unrealistic in projecting such, and have simply been used in this case for the sake of illustration. The US commercial market hit pre-bubble levels faster because it most likely trended up faster as well. There is still much too much supply in relation to demand in the market and interest rates (the prime macro determinant of CRE values) are at historic lows. They really have no way to go but up, most likely way up. Thus you should expect an explosion in cap rates, thus a severe compression in price going forward. Yes, severe even in comparison to what we have here. Remember, the boom occurred with a very favorable rate and lending environment, something we will not have for some time.

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  • Comment Link Reggie Middleton Friday, 11 February 2011 02:33 posted by Reggie Middleton

    No, because you don't create value out of thin air by doubling the wage. That is the same as trying to print your way out of a hole. If you were a small business man pulling in $300k per year in revenue with 4 employees, and your labor costs were doubled, your revenue does not increase with the labor costs. So, you respond by firing half of your staff. More money is not pumped into a system by forcing people to pay more.

    Only productivity brings non-contingent wealth into the economy - PERIOD!

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  • Comment Link Reggie Middleton Friday, 11 February 2011 02:31 posted by Reggie Middleton

    It's quite simple, actually, As long as nominal share prices are going up everybody is happy. It is irrelevant that they are being scammed up, and apparently irrelevant that most scams come crashing down.

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  • Comment Link Obsvr-1 Thursday, 10 February 2011 19:45 posted by Obsvr-1

    I am complete baffled as to why the equity investors in the banks are not more vocal and adamant in requiring MTM accounting standards. The institutional investors, hedge funds, pension funds should be outraged and screaming for a return of the MTM FASB stds.

    Where are they ???

    I wouldn't consider an investment into any of the big 5 TBTF institutions, unless I could get a claim on the bonus cash flow.

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  • Comment Link pie_row Thursday, 10 February 2011 11:16 posted by pie_row

    Would doubling the average wage (By pushing on the minimum wage) turn a lot of those NPAs into PAs? Or at least recoverable?

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  • Comment Link Jim Thursday, 10 February 2011 10:13 posted by Jim

    There is not necessarily a one-to-one correlation in NPA's and capitalization, though. Arguably, Japan's biggest drag was the Postal Bank, which was mired in a fat but rigid labor system. The financial sector in the US is not intertwined with unions and infrastructure to the same extent as Japan, and much of the labor supply in US construction was illegal. According to your graph, the US has returned to the pre-bubble mark (roughly 110) in three years (4Q07-4Q10), rather than Japan's seven years (1H91-1H99). The slope of the US line as of the end of 2010 is much steeper than your extension of it. In fact, the current slope looks to hit bottom about 2018, where your chart of property overhang from 2010 predicts the property bubble finally will shrivel.

    Already, the modest Obama infrastructure program is running out, and put-backs are starting to hit banks. The Bear only blew up in March of 2008, the first round of federal intervention came in October 2008, and it all finally hit the courts in 2010. We already are working through crappy real estate at twice the speed of Japan - or more. As you show, New York still dwells in the bubble, and DC/Baltimore continue to have soldiers moving in, roads being built, etc. National capitals always are bubble towns, and Wall Street is doing God's work for the Feds on Wall Street. However, price-to-rent ratio and declining prices suggest that the other shoe will drop on Southern California and the Pacific Northwest this year. However, Citi has foreign units, and the other big banks have units that can be consolidated or sold.

    This is where US banking differs markedly from Asian and European players. If one of those big state-owned banks busts in China, there will be blood, so to speak. If BofA lays off another ten thousand employees, there will be suffering at the Gap but Wal-Mart will gain greeters. I have worked for minimum wage and have also been laid off, so I certainly do not mean to make light of it. However, the likely high unemployment for the next couple of years is likely to translate into rage at the polls, which well could translate into reforms that look more like Reagan than Roosevelt. Firefighters and teachers already are losing pensions in all of this, but several of the big banks could make it out of this looking like Ford and GM. Morgan Stanley and Goldman Sachs may look more like Chrysler, but that is why you look in your crystal ball and publish a blog for a living.

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  • Comment Link Onsen Thursday, 10 February 2011 00:18 posted by Onsen

    As a CPA, I feel ashamed that our profession has allowed this "fraud" to go on without saying a word. Where is the AICPA? I think they are just a bunch of pussies like Moody, S&P and Fitch, satisfied with the crumbs from big corporations and scared of the big government.

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  • Comment Link Reggie Middleton Wednesday, 09 February 2011 11:30 posted by Reggie Middleton

    "Without MTM the government could allow banks to share real estate with the Chinese at inflated prices and let the market sort it out. Think of it as a Goldman Sachs program run by Geithner and Co. “Plump and dump” on a grand scale."

    That's what happened in after the '80s boom, when the Japanese bought up all of the overpriced US real estate and had it collapse on them. Much of your other line of questioning requires a crystal ball, such of which I do not have.

    "I am a little confused by the shift in a chart based on commercial property values to the lower capitalization of banks."

    The banks shrunk because they were never forced to realize their loses, hence on paper they grew their accounting earnings, but economically and in reality (which counts for global standing after some time), they simply mired in their NPAs.

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  • Comment Link Jim Wednesday, 09 February 2011 10:49 posted by Jim

    Great post, Reggie. I am a little confused by the shift in a chart based on commercial property values to the lower capitalization of banks. Don't the shifting fortunes of the Yen, which never really has been a world reserve currency, have an intermediate role in determining the interface between real assets assets and globally-valued money? While I certainly agree that marking assets to market would facilitate the kind of transparency needed to restore investor (and ultimately business) confidence, investors may or may not find it easier and more profitable to hold assets in Euro, Yuan, or other currencies. Most folks cannot simply print money and dump it from helicopters, as you have noted.

    Now, the big money seems to be managed increasingly by sovereigns, which is a big change from the 1980's and 90's. The Chinese and Japanese have recently announced that they want to start spending some of their dollar reserves on North American businesses and other assets. Won't Chinese factories in the US, Canada, and Mexico shift help stabilize the dollar? After all, long rates are beginning to rise, and a couple of the new Fed members are suggesting an end to bond purchases. Even with ZIRP, banks are beginning to notice small businesses again, so is the dollar going to break the crisis mark of 72 in the index? Without MTM the government could allow banks to share real estate with the Chinese at inflated prices and let the market sort it out. Think of it as a Goldman Sachs program run by Geithner and Co. "Plump and dump" on a grand scale.

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  • Comment Link Reggie Middleton Wednesday, 09 February 2011 08:25 posted by Reggie Middleton

    Yeah, it is rather disconcerting isn't it. I guess "Ignorance is bliss" encapsulates the whole thought process, eh?

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  • Comment Link profoundlogic Wednesday, 09 February 2011 08:12 posted by profoundlogic

    Ignorance is bliss! Great post, although sad to see where this country is headed. More extend and pretend is sinking the ship even faster. But I guess we can look forward to all those small business job creators who will revitalize the American economy. LOL!

    America - land of the free (free of accounting standards), home of the brave (brave manipulators of fiat curreny)

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