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SEC Issues Clarifications on Mark to Market Accounting



September 30, 2008 – Comments (14)

The SEC just released this statement clarifying that alternatives to mark-to-market may be used when there is no active market for a security or the only transactions in the market are distressed sales.

SEC Office of the Chief Accountant and FASB Staff Clarifications on Fair Value Accounting 

Key quotes:

"When an active market for a security does not exist, the use of management estimates that incorporate current market participant expectations of future cash flows, and include appropriate risk premiums, is acceptable."

"Distressed or forced liquidation sales are not orderly transactions, and thus the fact that a transaction is distressed or forced should be considered when weighing the available evidence."

I believe this will help free up the credit markets a bit.  Under mtm, banks may be carrying more reserves than they otherwise would to protect against a distressed security sale setting a new, lower price for securities.  I know it's not a cure for the problem, but it does help take some uncertainty banks have about getting back to lending off the table.  And it costs a whole lot less than $700 billion.

14 Comments – Post Your Own

#1) On September 30, 2008 at 9:31 PM, awallejr (36.09) wrote:

On the one hand people are concerned that there would be greater opaqueness with the change of this rule.  And to some extent there may be some truth, but the bottom line is there will always be opaqueness.  Even mark-to-market is opaque, but in a harshly negative way.  Companies, for example, hold commercial paper which they intend to hold to maturity.  This commercial paper is not in default.  Under mark-to-market the value can be forced at a lower value neverthless, and in a spiraling down market this becomes more and more inaccurate on true value.

I don't like mark-to-market because of the preceeding.  On the other hand I don't want financial institutions to just give arbitrary values either.  I think if you state the rules to where you can reflect value in cashflow/over time/non default it would be fairer.  And throw in enough double or tripl oversight/auditing to boot.

But this change shouldbe a supplement to the rescue plan, not a replacement, because it still doesn't create a market to sell these current loan bundles, which the rescue plan is designed to do.


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#2) On September 30, 2008 at 9:36 PM, devoish (65.10) wrote:


Bringing Accounting, Increased Liquidity, Oversight and Upholding Taxpayer Security 

1)      Require the Securities and Exchange Commission (SEC) to require an economic value standard to measure the capital of financial institutions.


This bill will require SEC to implement a rule to suspend the application of fair value accounting standards to financial institutions, which marks assets to the market value, no matter the conditions of the market. When no meaningful market exists, as is the current market for mortgage backed securities, this standard requires institutions to value assets at fire-sale prices. This creates a capital shortfall on paper. Using the economic value standard as bank examines have traditionally done will immediately correct the capital shortfalls experienced by many institutions.


2)      Require the Securities and Exchange Commission to restricting naked short sells permanently


This bill will require SEC to implement a rule that blocks naked selling, selling a stock short without first borrowing the shares or ensuring the shares can be borrowed. Such practices many times harm the companies represented in the sales and hurt their efforts to raise capital. There is no economic value produced by naked short sales, but significant negative effects.


3)      Require the Securities and Exchange Commission to restore the up-tick rule permanently.


This bill will require SEC to implement a rule that blocks short sales without an up-tick in the market.  On September 19, 2008, the SEC approved a temporary pause of short selling in financial companies “to protect the integrity and quality of the securities market and strengthen investor confidence.” This rule prevents market crashes brought on by irrational short term market behavior.


4)      “Net Worth Certificate Program”


This bill will require FDIC to implement a net worth certificate program. The FDIC would determine banks with short-term capital needs and the ability to financially recover in the foreseeable future.  For those entities that qualify, the FDIC should purchase net worth certificates in these institutions.  In exchange, these institutions issue promissory notes to repay the FDIC, counting the amount “borrowed” as capital on their balance sheets.  This exchange provides short term capital, with not cash outlay.  Interest rates on the certificates and the FDIC notes should be identical so no subsidy is necessary.


Participating banks must be subject to strict oversight by the FDIC including oversight of top executive compensation and if necessary the removal of poor management.  Financial records and business plans should be subject to scrutiny while participating in the program.


In 1982, Congress approved a program, known as the Net Worth Certificate Program, that allowed banks and thrifts to apply for immediate capital assistance.  From 1982 to 1993, banks with total assets of $40 billion participated in the program. The majority of these banks, 75%, required no further assistance beyond the certificate program.


5)      Increase the FDIC Insurance limit from $100,000 to $250,000.


The bill will require the FDIC raise its limit to provide depositors confidence that their money is safe and help eliminate runs on banks which are destabilizing to the industry.




Peter DeFazio

Member of Congress

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#3) On September 30, 2008 at 9:57 PM, russiangambit (28.71) wrote:

"management estimates" - that says it all. A good thing it is not. I have estimates of how much house is worth and how much stocks in my portfolio are worth, can I sell them to SEC? 

Smoke and mirrors again.

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#4) On September 30, 2008 at 9:57 PM, awallejr (36.09) wrote:

I have no problem with 4-5.  I do have a concern to actually legislate an accounting rule.  It really is not the place for Congress to do, especialy since most probably don't even know what the hell "mark-to-market" even means. 

As for the heading of no "bailout", I agree, we don't need a bailout.  We do, however, need a rescue plan. And the Paulson plan is daring enough to actually work, namely CREATING a market for currently unmarketrable assets thereby freeing up bank balance sheets and enabling them to start lending again.

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#5) On September 30, 2008 at 10:24 PM, StatsGeek (28.56) wrote:

So you support giving manager the discretion to lie about the value of distressed assets at their whim, so that nobody knows what the true worth is of all these companies?  Let's just make Enron-style accounting legal for everyone. The transparency will do wonders for our market. 


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#6) On September 30, 2008 at 10:30 PM, devoish (65.10) wrote:

Paulsons plan is the worst possible choice other than raising the amount. I am sure most Congressman know the meaning of "mark to market" now.

#3 slows things down without shutting trades off.

#2 is already a rule and enforcing it would prevent Paulson from crashing and stealing another bank.

#1 gets to the heart of the banks current problems, leaving only the issue of who are they are going to lend to if noone is left who can pay them back.

This "credit freeze" is a bank problem brought on themselves by lying about the  value of their assets. A reprieve on having to tell the truth will help them all feel comfortable that business as usual will go on.

This plan also apparently leaves us with 700bil we did not know we had, to spend on renewable energy to keep more of our money here instead of overseas. renewables save our oil dollars right away whereas with  nuclear we won't see a dollar of savings for ten years if at all. In the meantime we pay more for energy because we still pay for oil and start paying for nuclear for nine years before we ever see a kwt.

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#7) On September 30, 2008 at 10:38 PM, awallejr (36.09) wrote:

This is a credit freeze brought on because they can't sell the assets.  You can finger point all you want.  Alot of people are to blame, including congress, the regulators, even the average American.  And I am sure most Congressman go blank when you start talking accounting.

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#8) On September 30, 2008 at 10:55 PM, devoish (65.10) wrote:

No Stats, I am not in "support" of it except as opposed to 700bil or worse. The banks lied about their assets and were comfortable with that until "mark to market" made them come clean. Let them be comfortable  with the lies they are used to for a while. My understanding of "Fair value acconting" would be to allow them to do somethng like this from CR:

Not every homeowner with negative equity will default, in fact many of these homeowners will only be underwater by a few percent. But if we estimate one half of homeowners with negative equity will eventually default, use a 50% loss severity, and a 35% price decline (23.6 million households with negative equity), and use the median house price from the Census Bureau of $216 thousand, we get $1.3 trillion in mortgage losses for lenders.

I would rather see "mark to market" but a plan like this would allow our Pols to go on TV claiming a succesful remedy without risking my tax dollars to Paulsons whims/greed. The markets could bounce, the dollar could be strong/not weakened and I could go back to challenging Republicans on their campaign lies.

Remember that lost in all of this Paulson allowed baanks to temporarily take high risks with the USA's money that guarantees my deposits up to $100K. I had read that adds 3.4 trill to the swill.

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#9) On September 30, 2008 at 10:59 PM, devoish (65.10) wrote:


Are you suggesting the banks are all trying to hold out the longest so each bank can try to grab anothers 30% loss for 80% off?

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#10) On October 01, 2008 at 12:01 AM, awallejr (36.09) wrote:

Nah I am suggesting that all the banks are stuck and simply can't sell. What bank wants to buy assets that they may have to immediately write down?  Also, I suspect that banks are completely frozen now waiting on this plan.  Afterall why sell at 20 cents on the dollar when the Treasury may pay 30 cents.  Delay is only hurting. 


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#11) On October 01, 2008 at 12:50 AM, StatsGeek (28.56) wrote:

As a taxpayer, I can't wait to pay a 50% premium for junk debt that no one else can buy.

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#12) On October 01, 2008 at 1:08 AM, awallejr (36.09) wrote:

Yup THAT is where the cost to the taxpayer really is.  It isn't in the total 700 billion expense package.  It is the premium in the ultimate overpayment.  Which really is fine if it accomplishes what is hoped for.  Did you complain when the Gov't paid out 107 billion in rebates?  Nope.  While it meant money in your pocket, it still cost the coffers. 

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#13) On October 01, 2008 at 2:41 AM, hall9999 (90.78) wrote:

  No wonder TMA is up over 500% the last two days.  Mark-to-market is what killed them.  Just because you can't sell your assets on the open market doesn't mean they're worthless.  It just means that they can't be readily converted into cash.  Mark-to market forced them to say, "yes, most of our stuff is junk" and take huge write-downs when in reality less than 1% of their stuff is junk.

  The reason we're hesitant to drop it is that so many companies fiddled around and mixed and matched the good with the bad that nobody knows what's what.  In reality something like 10% of all mortgages will default.  But since they've made it so difficult to figure out where they bad is everybody is afraid if they buy some mortgages they may turn out to be part of that 10% so they treat all 100% like it is bad.

  Dropping mark-to-market won't help investors determine where the bad stuff is and it may even hinder freeing up the credit markets (who's going to buy debt just because the company says it's good).  On the other hand, cutting back on the forced write-downs will allow more companies to hang onto their debt until it matures or until it can be properly valued and thus a lot less "bailing out" will need to be done.

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#14) On October 01, 2008 at 3:02 AM, rd80 (95.18) wrote:

Devo - Congressman DeFazio's proposal sounds good.  Doesn't solve everything, but helps and doesn't cost $700 billion.  awellarjr does have a point about congress not needing to legislate accounting rules, appears the SEC and FASB can do that without congress, as they have.  The SEC could do 1-3 without congressional action.  The fact that they haven't is evidence that Cox hasn't been doing his job and  should resign/be fired. 

russiangambit, StatsGeek and awellarjr - If I were writing the SEC opinion, I would have added three more requirements for transparency:  Notes explaining why mark-to-market wasn't used, detailed explanation of how assets were valued, and what the mark-to-market values would have been.  Not perfect, but better than forcing mtm in an environment where there is no functioning market and lets everyone know how assets were valued. 

I would much rather have functioning markets and mark-to-market accounting.  But, if the only prices in the market are distressed fire sales, mtm is crazy.  Banks have to sit on capital to defend against someone else selling assets in desperation and setting a new low price.  That sets up an easy play for market manipulators - sell some securities dirt cheap to set a new low bar mtm benchmark while you're shorting XYZ bank.  XYZ bank has to raise capital because of the asset write down.  Rinse, repeat until you drive XYZ to the arms of the FDIC.  'course you have to wait a few days before you can short again. 

(rant) In case no one can tell, I'm pissed at how this whole mess has been handled.  Paulson comes to congress asking for $700 billion that my kids and grandkids (none of those yet) will have to pay back either in taxes or inflation.  It's a 'crisis' even though anyone with a two functioning brain cells could see it coming months or years ago.  Meanwhile, no one's bothered to even try no cost options that might help like this accounting opinion or Congressman DeFazio's package.  They aren't panacea's and don't solve the underlying problem, but they may keep the system from doing stupid things in response to crazy markets.

At this point, I don't much care who's fault it was.  Finger pointing from either side isn't solving anything.  Democrats pushed looser lending standards, Republicans expanded those programs under Bush, McCain pushed for enhanced regulation of FNM and FRE and was shot down, Obama pointed out some of the problems with mortgage lenders and no one listened...  Both sides took huge amounts of PAC money and were more than happy to ride the gravy train.  As long as home prices went up everything worked just fine.  Problem is, very few considered prices might fall someday.  Every one of the SOB's should be fired - but that isn't going to happen. (/rant) 

Thanks for all the comments, I think this is a record for one of my posts :) 

Fool on! 

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