Comments on: What Home-Loan Banks reveal about the effects of mark-to-market

By: Home Loans

Home Loans — Wed, 27 May 2009 11:59:45 +0000

As the UK's major banks are set to reveal their annual results, … has a sizeable exposure to the leveraged loans market but analysts say it is more likely …

By: Kyle

Kyle — Sat, 23 May 2009 04:17:43 +0000

Ed,
I'm not sure I follow you on that either. My point is that it has really NOT changed, and people are trying to make it seem like it did. To be honest, I'm glad most people do feel that way, because it means those idiots in Congress will hopefully leave well alone. The capital raising that just occurred due to stress test mumbo jumbo has no connection to FSP 157-4. It is a requirement of GAAP to disclose when an accounting change has affected reporting, in order to explain the change. Out of the probably fifty different financial institution 10-Q's that I've looked at, only one, Wells Fargo, indicated that 157-4 had a material impact on their reporting, which it did to the tune of 4B. The other 49 explicitly state, “157-4 had no material impact on our reporting, and we do not expect it to in the future.” It's in the notes for anyone to read. I just do not understand how an accounting change which explicitly has had no impact on reporting (this is the ultimate point I am trying to make, the rule change was and has been almost completely meaningless), could lead to changes in whether or not a bank is undercapitalized.
I hope I'm not coming off as confrontational or anything, but I feel as though I might be. I really enjoy your blog and have been reading it for over a year now, and I have learned a great deal from your posts.

By: Edward Harrison

Edward Harrison — Fri, 22 May 2009 22:34:14 +0000

I would like to take your view that the information remains the same but the accounting has changed and this means nothing materially, but evidence shows that accounting changes behaviour. Look at what we just witnessed as a result of the stress tests, a massive $40 billion capital raising exercise by banks including Citigroup, which were shunned.

At a minimum, the mark-to-market accounting changes mean an FDIC seizure is less likely for most banks and that is bullish for shares.

By: Kyle

Kyle — Fri, 22 May 2009 18:48:50 +0000

I'm not saying accounting doesn't matter (I'm an accounting grad student, it better matter!), I'm saying that people are making this out to be something that it isn't. The price of the asset is still the same as it was before. The extent of any writedown is still recognized to the extent it was before. If you have a loss on the security, it still gets recognized, it just gets recognized in two places. I don't know, I just find it hard to believe people could be so easily deluded into thinking that because it doesn't flow through the I/S first, it doesn't matter. The only potential effect I see it having is on various P/E measurements like as-reported/gaap earnings. There might be a psychological/sentiment effect from moving it from the I/S to S/E, I will agree with that, but nothing has changed from a fundamental standpoint. People with real amounts of money can't possibly be fooled into thinking that because the writedown is in OCI, its no longer important. Or can they?

By: Bob_in_MA

Bob_in_MA — Fri, 22 May 2009 13:04:56 +0000

It makes sense that if the banks are able to drag out the write-downs until the losses are realized, then they may be able to cover the shortfalls with using the profits they are generating on the huge margins.

But the problem for the economy at large is that if the benefits of the ultra-low rates are being hoarded by the banks merely to minimize capital raising, then the overall economy is not getting the pick-me-up intended.

And that is going to feedback into higher loss rates that banks need to recover...

I think that's the thinking behind those who say its better to take-over the banks, remove the bad assets at once, and recapitalize them. It's not that the banks couldn't otherwise recover if all the advantages of the Fed policy are used by them for that purpose. It's that those advantages are lost to the rest of the economy to save the stockholders and managers of the banks.

And later, the price of all this easing will be paid by the rest of the economy.

The question is, is the sole purpose of monetary policy to keep poorly run banks afloat?

By: Edward Harrison

Edward Harrison — Fri, 22 May 2009 07:39:51 +0000

Kyle,

not all investors are rational and the price of an asset is determined by the marginal buyer so these accounting changes have an effect. Look at how bringing option accounting through the income statement changed behaviour in Silicon Valley.

Accounting matters.

By: Kyle

Kyle — Fri, 22 May 2009 00:29:26 +0000

I fundamentally struggle with this issue, because I see so many people posting about it. The only thing that FSP 157-4 changes, is that it effectively splits the unrealized loss between earnings and OCI. The loss is still there, it's just a direct to equity adjustment, as opposed to flowing through Income and then subsequently Retained Earnings. The end result is the same, you have less equity, and it is displayed there for any one to see. If anything, now you can tell how much of the impairment they think is permanent, and how much is not. If they're wrong it makes no difference. The I/S says impairment of x% of the writedown, the SE statement contains the rest. The whole loss is still recognized. Do you really think real and rational investors do not understand or are somehow fooled by this, simply because the effect is split between the I/S and B/S? I just have a hard time believing that.