Wednesday, March 11, 2009

Testimony Posted For Mark-To-Market Hearing; Sen. Dodd Considers ‘Breakers,’ Niederauer Sees MTM As ‘Gas On A Fire’

Talk about transparency: all of the testimony has been posted to the House Financial Services Committee website in advance of its hearing today on mark-to-market accounting (MTM). (The hearing begins at 10a.m., watch for a summary in the FEI blog.)

I found no real surprises in the prepared written testimony, which falls into four buckets:
  1. Standard-setters and regulators: FASB Chairman Robert Herz, SEC Deputy Chief Accountant Jim Kroker, and OCC Deputy Comtroller for Regulatory Policy, Kevin Bailey, (collectively, Panel 1 at the hearing) whose written testimony appears to me to be pretty much 'stay the course' - i.e., as SEC recommended in its Dec. 30, 2008 report to Congress, and as FASB announced on Feb. 18 it will proceed to do, FASB is developing 'application guidance' for companies and their auditors to apply the existing standards such as FAS 157, Fair Value Measurement, in inactive markets.
  2. Investor reps: Panelists on panel 2 who are traditionally referred to on these sorts of panels as 'investor reps,' include Jeff Mahoney of the Council of Institutional Investors, and Cynthia Fornelli of the Center for Audit Quality.
  3. Bankers: current and former bankers and banking regulators regulators like Tom Bailey, Lee Cotton and William Isaac, who urge action ranging from further guidance (Bailey and Cotton) to suspension of FAS 157 (Isaac).
  4. Policy analysts: Tonya Beder, of SBCC Group, and Robert McTeer of the National Center for Policy Analysis, who says , "Much of our recent wealth destruction has resulted from slavish adherence to an accounting dogma that never should have applied to banks and other regulated financial intermediaries in the first place."

Put on your Decoder Rings
Allow me to throw in my two cents: I hope the Congressmen, regulators, bankers and others won't 'talk past each other' at this crucial hearing, which is easy to do, when dealing with a highly technical subject replete with its own lingo.

Indeed, former SEC Chairman Christopher Cox was fond of referencing in speeches his desire to cut back on jargon and simplify reporting so investors would not have to turn to 'decoder rings.' At the same time, he wisely noted, there is a need to write clear standards so the people applying them will not be subject to 'gotcha's.' (See Cox' speech at the New York Economic Club, Dec. 12, 2005.)

Here's some of the jargon to watch out for:

  1. the definition of fair value, and whether FAS 157, which became effective in 2008, really 'changed' anything. As much of the testimony states, (and as analyst Jack Ciesielski states in his post about the hearing in his AAOWeblog earlier this week, The Lynch Mob Forms), FAS 157 did not require any new assets to be marked to market or carried at fair value, it simply created a 'consistent defintion' for how to apply fair value. Thus, while no new assets were required to be carried at fair value, how did the 'new, consistent' definition of fair value differ from the old methods? A plain English dialogue over 'what changed' in terms of actual practice in how fair value was applied pre- and post-157 may be enlightening.
  2. the generic concept of 'fair value' vs. the specific definition and requirements relating to fair value set forth in FAS 157. That is, someone can be 'pro fair value' and still believe there should be improvements to FAS 157. As some of the panelists note in their testimony (see especially Beder and Isaac), there have historically and continue to be (in some sectors of professoinal practice in the valuation field) a number of methodologies to arrive a 'fair value' - with market values being just one of them.
  3. 'application guidance' vs. 'improvement' vs. 'modification'. Here is where all the panelists and Congressmen could conceivably walk out of the room thinking they reached a consensus for 'improving' e.g. FAS 157, but could have polar opposite views on what 'improve' really means, e.g. does 'improve' mean 'modify' - which to some implies an amendment of the fundamental principles in a standard? Or, does 'improve' mean provide 'application guidance' issued to preparers and auditors under the belief that the implementation issues are resident at their end, in the application of a standard, vs. being resident in the standard itself? Note that the Emergency Economic Act of 2008 asked the SEC to study and opine on whether there should be a suspension - or modification - of FAS 157. The SEC's answer was clear that they did not believe there should be a suspension of FAS 157. On the question of 'modification' - that appears to be more of a gray area.

Dodd Says Congress Should Not Set Accounting Standards, But Breakers Should Be Considered

Senator Chris Dodd (D-CT), responding to a question at the U.S. Chamber of Commerce 3rd Annual Capital Markets Summit on March 11, 2009 said it is worth considering whether a ‘breaker system’ could provide some relief on mark-to-market (MTM) accounting. Dodd’s comments came during a brief Q&A following his formal remarks. In connection with the Capital Markets Summit, the U.S. Chamber Center for Capital Market Competiveness issued a declaration entitled: Eight Actions to Restore and Strengthen Capital Markets.

Doug Barnert, Executive Director of the Group of North American Insurance Enterprises (GNAIE), raised the question on MTM at the Chamber program. Noting that the House Financial Services Committee was slated to conduct a hearing on MTM on March 12, Barnert asked Dodd if the Senate Banking Committee was planning to do the same, and what his position was on the matter. He added, “There are two camps that are the most obvious, which are (1) suspend all MTM, and (2) don’t do anything, everything is OK- rosy picture type. I think you’ll find most people in this room don’t fall into either one of those camps, but believe some legitimate action can take place; some needs to be long-term, well thought out, like the regulatory reform you are talking about, but some needs immediate action. And so the question is, without legislating accounting standards, what type of actions do you think the Congress can take on moving forward on this?”

Dodd, whose home state of Connecticut includes the Financial Accounting Standards Board, based in Norwalk, CT, responded, “”First of all, I’ve been over the years - although I have only chaired this committee the last two years, but as a member of the committee, even when Dick Shelby was chairing the committee, or Paul Sarbanes or others, I have vehemently opposed the Congress getting in the business of setting accounting standards.” He continued, “Be careful what you wish for - once you set that precedent, you open up that door, the idea that by a vote of 51 to 49 in the Senate we sort of set a FASB standard, is frightening to me, because then it becomes… as dangerous as it can be.”

He continued, “MTM is a very legitimate question, and certainly there have been legitimate ones in the past as well; I’m not suggesting those advocating … are incorrect, but … I urge you not to get Congress involved,” and repeated, “be careful what you wish for.”

Dodd described the procyclical environment as “spirally down …at warp speed.”

As a potential solution, he noted, “I had a long chat with Gene Ludwig, and he suggested something that had some appeal: we should have a breaker system, [to be able to] step in and provide some relief.” NOTE: Ludwig, a former Comptroller of the Currency, is the founder and CEO of Promontory Financial Group, and also serves as a member of the FASB-IASB Financial Crisis Advisory Group (FCAG).Read more about FCAG here, including a link to FCAG's request for comment due April 2, and links to summaries of the most recent (March 5) FCAG meeting by Steve Burkholder courtesy of BNA.

It appeared from Dodd’s remarks at the Chamber’s Capital Markets Summit that the concept of ‘breakers’ (akin to ‘circuit breakers’) were being given serious consideration in some circles. He stated, “Some thought is going into that - to see if there isn’t some breaker system regulators could have used.”

However, striking an analogy with actions taken on short sales, Dodd noted that former SEC Chairman Christopher Cox suspended short selling for a time, but “there was a problem with that, .. [it] created more problems than it solved.” He added, you “can’t pull it back and forth,” or you “get the kind of reactions you saw when that occurred.” He also noted “the uptick rule might be helpful at a moment like this,” noting that SEC Chairman Mary Schapiro has testified she would consider reimposing it.

Closing his response on the issue of MTM, Dodd said, “I am in the category of finding some kind of mechanism - not to be used at any old time - but to put brakes on … [rather than having things] spinning out of control.”

You can view the exchange between Barnert and Dodd on the question of mark-to-market accounting if you go to 03:13:15 on the Chamber’s archived webcast.

NYSE-Euronext’s Niederauer: MTM Like "Gas On A Fire”
Another keynoter at the Chamber Capital Markets Summit who touched on the topic of MTM was NYSE-Euronext Chairman Duncan Niederauer. “To go back to the MTM question,” said Niederauer, referencing the question posted to Sen. Dodd earlier, he said, “we’ve got to balance ideals with reality.”

Noting recent remarks of Berkshire Hathaway Chairman Warren Buffett, Niederauer added, “We might say with a long-term view, MTM was right, but it came along - as Mr. Buffett has said, at a very bad time.”

Niederauer compared the timing of implementation MTM accounting – under the new measurement regime introduced in FAS 157, Fair Value Measurement, which became effective in 2008 – to “one downturn away from effectively bringing gas to a fire.”

He noted MTM can have a broad impact on a company’s balance sheet, and added, “Not to say MTM rules were not right, [but] the question is, do we relax them for a moment?”

Niederauer also made some specific suggestions for areas of focus. You can see Niederauer in person when he gives a keynote address at FEI’s Summit conference May 4-6 at the Gaylord Texan Resort in Grapevine, Texas. Become a new member by April 6, and attend our Summit conference for free – includes free CPE! If you have questions about FEI membership or the Summit conference, contact me at or 973-765-1046.

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Edith Orenstein said...

Francine McKenna of Re: The Auditors noted a very significant quote made by Niederauer in her 'live tweeting' (a twist on 'live blogging') from the Chamber Summit. This particular quote was made in his general opening remarks, but also has significant bearing on why some believe mark-to-market is not necessarily representative of 'fair' value, (vs., e.g. discounted cash flows), particularly in inactive or dysfunctional markets. (CFA Vinny Catalano, who I recently interviewed in this blog,has pointed out for over a year that psychological factors can outweigh a presumption that we have 'efficient' markets. Beyond that, as Niederauer pointed out at the Chamber Summit, as tweeted by McKenna, the market has become a trader's market, not an investor's market. His comment implies market prices are being depressed by short-term traders, who hold a liquidation view, not long-term investors. This has tremendous implications for those who believe in market value (quotes by 3rd party 'marketplace participants' or 3rd party indexes) represent what was traditionally viewed as a market value (in deep, liquid markets, with a greater proportion of long term investors) as a proxy for 'fair value'. Read McKenna's tweet of this key Niederauer quote here: and read her complete coverage of the U.S. Chamber's Capital Markets Summit in her blog here:

Anonymous said...

Traders' market, investors' market, shmarket. Splitting the wrong hair. It's a traders' market when the investors leave, and the investors began leaving long before the assets were marked to frozen - no, investor-less - markets. Investors left much as they left in 1987 or 1998, in a "flight to quality" fueled by a risk aversion that was as deep as their previous greed for yield The most troubled market (and the basis for trouble in CDO, ABCP, SIV etc.), the private MBS market, ballooned by low interest rates and then teaser rates in preposterous loan vehicles, relied for its value on the underlying housing market. Once that housing market stopped rising - in late 2005, 2006, depending what locality and what index you reference - the least committed (fraudulent, entirely dependent on repeated cash out refinancings to maintain life style/debt) began bailing. The investors who understood this problem began retreating as well. The investors who looked at yield and rating (in that order) - the CDOs, SIVs, etc. - kept on buying. It was only in 2007, as the mortgage banking units that made and lost money servicing (etc) the most credit-leveraged and untenable loans began to fail, that the broader market woke up. The plain fact is not that marking to market destroyed wealth that still exists if only the auditors would use the right model, but the wealth was artificial, it has begun to evaporate and will continue to evaporate. Until the decline in housing markets & now decline in employment and household incomes stops, prudent investors (which even the previously risk-loving have become) are unable to evaluate with any reliability expected returns on any of these "troubled," "distressed," "illiquid" assets. The risk premia therefore are very wide, the market values deservedly low. That is how market works. Anything else would be the emperor's new clothes. Whether these bonds really can pay contractual cash flows cannot be prudently asserted in current economic conditions.

gene said...

FAS 157 extends far beyond bonds. Impairment tests for intangibles now must reflect market values based on the very zany "market participant" theory.
Further fun from the FAS as interpreted by the Big 4 includes some inventive new ways to estimate costs of capital. CPA firms national offices are dictating that everyones WAC must be higher than 2007, even though interest rates are down.
While financial firms are the most visible, multi-billion goodwill and intangible writedowns are being affected by MTM.

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