Mark to market, FAS 157

[Biggus Piggus]

Bullets from presentation by Don Young, former FASB board member.

Big question is whether a security is declining in value because of market risk or risk related to that particular security.  Most of the securities in crisis have legitimately been marked down due to security-specific risk.

That means bad lending + insufficient capital.

Fair value = price that would be received to sell an asset in an "orderly transaction" not a forced liquidation or distressed sale.

Prefer quoted prices in active markets for identical items, after that other inputs including management judgment.  FAS 157 required management to use market pricing when active markets exist.

When active markets do not exist, FAS 157 requires that management estimate the market price based on expected income from the security and market-derived risk premiums.

When company managements subjectively value their security assets, it is very difficult to rely on those valuations and compare them with other companies' assets.

FAS 157 did not require expanded use of mark to market accounting.  It added a consistent method for measuring fair value, one that should have been in place before.

FAS 115 (1993) and FAS 133 (1998) govern most securities involved in the credit crisis.

Available for sale accounting requires that the balance sheet reflect the lower of cost or market value of securities.  The large balances of available for sale securities may have caused financial institutions to take on too much risk.

Loans marked to market as a % of total assets

65% JP Morgan Chase
63% Citigroup
52% Bank of America
38% Wells Fargo
30% SunTrust
25% Washington Mutual

WaMu carried 75% of its loans at cost with a loss reserve that it estimated.

He recommends:

Expand GAAP accounting to include full fair value for financial instruments.
Available for sale accounting should be eliminated.
Most hedge accounting should be eliminated.
Investors should support FASB and FSP 157-d, which gives guidance on how to value assets in absence of a liquid market.
Regulators should be able to reduce capital requirements in times of stress & also adjust regulatory capital requirements for risky assets.
Counterparty risk should be measured and monitored globally.
Investors should be more involved with risk management in their investments.

Q&A

Mr. Young was very critical of the SEC for being disorganized and irrational during the Bush administration.

Future accounting standards will allow less capitalized assets in business combinations.

Credit markets are bad because banks don't trust each other's accounting, and undermining fair value accounting would make the problem worse.

Banks want the freedom to mark mortgage-backed securities to their own estimates of value, assuming that the housing market will recover.  Assigning a fairy tale valuation to mortgage-backed securities won't restore confidence in the banking system.