SabaziotatosonFair-Value,Mark-to-Market Accounting,and other issues: July 2008

5/19/2008: Fair-Value Accounting's "Atmosphere of Fear"

Excerpts from Fair-Value Accounting's "Atmosphere of Fear"
by David M. Katz

Senior finance executives at some of the biggest financial institutions are calling on the Financial Accounting Standards Board to reassess its new fair-value standards in light of the banks' experience in the subprime crisis.

The shift to fair-value accounting in the midst of the crisis spawned an "atmosphere of fear" that lead to a "lockdown" in the use of judgment in valuing securities, they said last week at a Standard & Poor's conference provocatively titled "Is it Time to Write Off Fair Value?"
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One part of the controversial new mark-to-market standard, FAS No. 157, Fair Value Measurements, that needs a second look is a provision that says that market prices must be assessed on the basis of market participants that are "willing" to buy or sell the asset or liability but are not "forced or otherwise compelled to do so," according to Bob Traficanti, head of accounting policy and deputy controller of Citigroup.

Traficanti, a former FASB project manager who worked on FAS No. 133, the board's hedge-accounting standard, suggested that some of the prices that the bank had to come up with indeed felt coerced. One of the "unintended consequences" of the new rules has occurred at Citigroup "in situations where we have securities with little or no credit deterioration, and we're being forced to mark these down to values that we think are unrealistically low," he said. "I would ask the FASB to ... back-test to see how this really worked."

Similarly, Christopher Hayward, a Merrill Lynch senior vice president and finance director, asked FASB to go back and look at the results of the standard with an eye to the "almost borderline panic" that beset many companies at the prospect of gauging the fair value of securities with no semblance of a market. Many firms in the financial-services industry lacked the models to create hypothetical markets when the real ones dried up, he added.

But not only the financial firms were unprepared, Hayward said. Their auditors also found themselves fumbling in the dark. As result, the Merrill executive said, they advised their clients, "Let's just mark [an asset or liability] down; there's no question if we mark it down heavily."

The intense conservatism that ensued eclipsed the role of judgment in marking instruments to market, according to David Johnson, the outgoing CFO of the Hartford Financial Services Group. He called papers issued last fall by the Center for Audit Quality (CAQ), an offshoot of the American Institute of Certified Public Accountants, "basically a shoot-to-kill order for anyone who would exercise judgment."

07/01/2008: Are Bean Counters to Blame?

Excerpts from Are Bean Counters to Blame
by Andrew Ross Sorkin

[Stephen A. Schwarzman], the co-founder of the private equity giant Blackstone Group, has been espousing this view for weeks over lunches and at cocktail parties around the globe. It’s a controversial hypothesis, which others have put forward before, and it has sparked plenty of debate within the industry. But Mr. Schwarzman is convinced that the rule — known as FAS 157 — is forcing bookkeepers to overstate the problems at the nation’s largest banks. ... The president of Blackstone, Hamilton E. James, goes even further. FAS 157, he said, is not just misleading: “It’s dangerous.”
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FAS 157 represents the so-called fair value rule put into effect by the Federal Accounting Standards Board, the bookkeeping rule makers. It requires that certain assets held by financial companies, including tricky investments linked to mortgages and other kinds of debt, be marked to market. In other words, you have to value the assets at the price you could get for them if you sold them right now on the open market.

The idea seems noble enough. The rule forces banks to mark to market, rather [than] to some theoretical price calculated by a computer — a system often derided as “mark to make-believe.” (Occasionally, for certain types of assets, the rule allows for using a model — and yes, the potential for manipulation too.)

But here’s the problem: Sometimes, there is no market — not for toxic investments like collateralized debt obligations, or C.D.O.’s, filled with subprime mortgages. No one will touch this stuff. And if there is no market, FAS 157 says, a bank must mark the investment’s value down, possibly all the way to zero.
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Some analysts, even insiders, say banks like Citigroup and Lehman Brothers marked down some of their C.D.O. exposure by more than 50 percent when the underlying mortgages wrapped inside the C.D.O.’s may have only fallen 15 percent.

Bob Traficanti, head of accounting policy and deputy comptroller at Citigroup, said at a conference last month that the bank had “securities with little or no credit deterioration, and we’re being forced to mark these down to values that we think are unrealistically low.”