Six More Weeks Of ....?

... winter, according to Punxsutawney Phil (via AP), who also proclaimed the nearby Pittsburgh Steelers world champions after their Super Bowl victory last night.

But, can prescient Punxsutawney Phil tell us how much longer the economic downturn will last? He is not the only one accused of keeping his head in the ground too long - in a front page article in today's New York Times by Vikas Bajaj and Stephen Labaton entitled, Risks Are Vast In Revaluation of Bad Assets - which discussess expectations the U.S. government may announce formation of a 'bad bank' to aquire, say the NYT writers - up to $1 trillion or more of toxic assets from banks - one of the thorniest issues of debate is the price at which the government would buy such assets. Former SEC chief accountant Lynn Turner is quoted in the article saying, "To date, the banks have stuck their heads in the sand, and demanded that they be paid the price of good apples for bad apples." However, writers Bajaj and Labaton also note, "A frequent refrain in Washington and on Wall Street is that there are no current market prices for toxic securities... Big banks and other owners of mortgage investments have argued that the low market prices reflect fire sale prices."

There are definitely two sides (if not more) to the pricing debate. The article adds, "[P]eople who buy and sell these investments say that is a simplistic reading of the problem. They say most kinds of securities can be valued and are being traded, but trading has slowed as sellers and buyers disagree about what that price should be." Quoting S&P Managing Director Michael Thompson, the article notes: "This is not rocket science, this is straight bond math." However, S&P's Thompson added: "We are not masters of the universe who can predict the macroeconomic environment."

Additionally, the article notes, "Many analysts do not trust what they are told about the quality of the securities and loans held by banks and other financial firms. Most banks provide only a very general description of their holdings, because they consider the information privileged."

If you follow FASB meetings, you will recogize the above refrain, as some assert the wide disparity between book value and market value of financial institution stock prices demonstrates a priori overvalued assets; while others will say the opposite problem is at play, citing their believe in either overly conservative accounting rules, or overly conservative application of those rules. The SEC acknowledged in its Report to Congress on mark-to-market accounting, issued at year-end, that even after guidance issued by the SEC and FASB in the fall of 2008 on valuing assets in illiquid markets, further guidance may be needed. As we noted previously, support for a reexamination of FAS 157, in light of lessons learned through application in the real world during the past year-plus, was voiced in a joint comment letter filed with FASB on Nov. 25, 2008 by FEI’s Committee on Corporate Reporting and the U.S. Chamber of Commerce’s Center for Capital Market Competitiveness. (See FEI CCR-USCC CCMC letter.)

On the fair value front, we reported on a related development on Friday, in which FASB released a proposal that would require increased disclosure of fair values on an interim (quarterly) basis - expanding on existing disclosure requirements for annual disclosure of fair values - beginning with first quarter 2009 financial statements.

While an earlier proposal released on Christmas Eve had contemplated requiring disclosure of not only fair values computed under FAS 157, Fair Value Measurement -- but also disclosure of hypothetical 'incurred loss' amounts suggested made by some participants in the FASB-IASB and SEC roundtables on the credit crisis and mark-to-market accounting, respectively, held last fall, comment letters on FASB's December proposal (Proposed FSP FAS 107-a) did not support the proposed incurred loss dislosures, indicating they would lack usefulness, understandability and comparabiliy and be overly complex to compute. Therefore the new proposal, Proposed FSP FAS 107-b and APB 28-a, is scoped more narrowly to fair value disclosures. Note: some comment letters raised objections to some of the proposed fair value disclosures as well.

NYT's Bajaj and Labaton add in their article today: "[T]he government, using its power as a big investor, could compel the banks to divulge more specific data, without giving away the names of individual bonds or loans, analysts said. The market could then do its own analysis on what the assets are worth." They then quote Anthony Lembke of hedge fund MKP Capital Management, saying: "At least it would give the government one objective measure of the value of these assets. In the absence of transparency and clarity, investors are going to assume a value that will be conservative and then add a risk premium.”

Meanwhile, as noted on the SEC's spotlight page on SEC Actions Taken During Turmoil in Credit Markets, the SEC's Division of Corporation Finance has been encouraging companies to disclosure more information, as noted in Corp Fin's letters to public companies (referred to informally as SEC's 'Dear CFO letters') in Dec. 2007 and March 2008.

Will an Exemption Be Issued To Facilitate Bad Bank?
Another point of interest in the SEC's list of actions taken during the credit crisis is that the SEC issued a number of exemptions and temporary emergency actions in the fall of 2008 in response to the credit crisis, including the exemption to allow a central counterparty for credit default swaps, and a number of emergency orders relating to short sales.

Additionally, staff of the SEC and FASB issued this letter on Oct. 24, 2008 (posted on U.S. Treasury website) indicating that staff of the two agencies would not object to certain accounting treatment of warrants under Treasury's TARP program.

With the U.S. Set for 'Big Bang' Financial Cleanup as reported by Krishna Guha in the Financial Times, and global counterparts preparing similar plans, as reported in Making the Best of Bad Banks by Hugo Dixon in the NYT, Karey Wutkowski and Rachelle Younglai of Reuters reported Jan. 30 in Accounting Fix Could Pave Way for U.S. Bad Bank: "A selective suspension of fair value accounting is one idea being floated as U.S. policymakers wrestle with how to price bad assets the government might buy from the distressed banking industry.
The accounting fix suggested by a bank industry group [the Financial Services Roundtable] could prevent banks from having to broadly mark down all assets to the prices a government-run "bad bank" might pay."

Another view is provided in Fix the Accounting, Then Fix the System, by Yves Smith in the Naked Capitalism Blog, linking to Roger Ehrenberg's post by the same name in his blog, Information Arbigrage. (Props to CPATrendlines' Rick Telberg for pointing out the above two articles among many others in his 'reading' list via Twitter in his CPAtweets.)

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