Thursday, April 2, 2009

FHLB Chairman Disgusted With FASB Accounting Alchemy, Quits

When the man in charge of the second largest borrower in the U.S. is willing to lose his job due to his discomfort with the FASB's shift in accounting rules, you can bet that the tragic fallout of all the "market buoying" recent events is only a matter of time.

Somehow this noteworthy event, which happened over a week ago, passed substantially unnoticed until Zero Hedge friend Jonathan Weil at Bloomberg dug it up. Charles Bowsher, who was most recently Chairman of the Federal Home Loan Bank System's Office of Finance and previously served as U.S. comptroller general may be the only truly honorable man in the socialist nexus of politics and finance. The reason for his departure from this critical post - his discomfort in vouching for the banks' combined financial statements. And as Weil puts it succinctly: "Now the question for taxpayers is this: If Charles Bowsher can’t get comfortable with these banks’ financial statements, why should anybody else be?" Why indeed.

If Bowsher was merely involved with some marginal organization, this could be perceived as a hypocritical attempt to score populist brownie points. However, the FHLB is among the governmental entities at the heart of the current problem. Zero Hedge has written previously about the FHLB and its critical role in the ongoing housing crisis, but in a nutshell "The Office of Finance issues and services all the debt for the 12 regional Federal Home Loan Banks. That’s a lot of debt -- $1.26 trillion as of Dec. 31, making the FHLBank System the largest U.S. borrower after the federal government. The government-chartered banks, which operate independently, in turn supply low-cost loans to their 8,100 member banks and finance companies. If any of the FHLBanks were to fail, taxpayers could be on the hook."

Ah, the poor taxpayer about to get duped one last time. And the immediate reason for Bowsher's decisions: his concern with the methods used for determining when losses on hard-to-value securities should be included in banks’ earnings and regulatory capital. And it gets much worse:
For the fourth quarter of 2008, the FHLBanks said their total preliminary net loss was $672 million. It would have been many times larger, had they included all their red ink.

The year-end balance sheet at the FHLBank of Seattle, for example, showed $5.6 billion of non-government mortgage-backed securities that it says it will hold until maturity. Yet the estimated value of those securities was just $3.6 billion. The bank, which reported a $199.4 million net loss for 2008, said the declines were only temporary. They’ve been anything but fleeting, though. Most of those securities have been worth less than they cost for more than a year.

The FASB’s rules on this subject, which have never been well defined, are now in flux. Today, after caving in to pressure by the banking industry and members of Congress, the Financial Accounting Standards Board is set to vote on a plan to relax its rules on mark-to-market accounting, so that companies can disregard market prices and ignore losses on their securities indefinitely.
Bowsher is not new to taking hard political stands:

As comptroller general, he was in charge of the General Accountability Office, the investigative arm of Congress. At his direction, the GAO was among the first to warn the public about the brewing savings-and- loan crisis during the 1980s. He testified before Congress in 1994 that there was an “immediate need” for “federal regulation of the safety and soundness” of all major U.S. derivatives dealers. (How’s that for prescient?)

Most recently, in 2007, he led an independent committee that issued a blistering report on financial missteps at the Smithsonian Institution, whose board of regents included U.S. Chief Justice John Roberts.
And how does the FHLB spin this event?

"Mr. Bowsher has expressed his concerns to me around the complexity of valuing mortgage-backed securities and the process of producing combined financial statements from the 12 home loan banks. I don’t think it’s appropriate for us to speak for Mr. Bowsher."
So: to paraphrase - one of the men who knows the ins and outs of the financials of banks involved in the mortgage crisis more intimately than even Bernanke and Geithner, let alone Obama, is saying that the newly implemented changes by the FASB will throw the whole system into tailspin and he want none of it.

If this isn't the most damning condemnation of the Kool Aid the administration, the Treasury, the Fed, the FASB, the FDIC, and all the other alphabet soups are trying to make the common U.S. citizen drink and have seconds, then nothing else possibly could be.... of course until Bowsher is proven right and everything collapses into the smoldering heap of defaulted MBS still marked at par on various liquidating banks' balance sheets...

Oh and yes, let's hold a moment of silence for Lehman which held billions of mortgage backed securities that it too was "holding until maturity." Well, Lehman is no more, and all these securities now trade, in the form of the company's general unsecured claims, at the generous price of 12 cents on the dollar... Furthermore, one can't say the market is illiquid - the bid-ask spread is only 1 cent. And as there are over $150 billion of these claims floating around, one can't say the market is in any way limited from a price discovery standpoint.

Maybe if more honest people follow in Bowsher's unique example, the general population will finally start seeing though the everyday lies and misinformation coming out of D.C. Sphere: Related Content
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Anonymous said...

Thank God we had one honest man of principle. I had all but lost hope for even that.

Anonymous said...

do you think Geithner actually believes the BS that spews out of his mouth or is he so stupid that he thinks this is an illiquidity crisis rather then just a bunch of horribly made loans?

Anonymous said...

The atlas shrugged parallels get more uncanny every day.

Anonymous said...

Geithner made the same exact mistake in '97 according to Keating, so maybe its all he knows how to do?

Anonymous said...

thank God we have Zero Hedge to inform us about this.

Anonymous said...

Thank you ZH for explaining this.

I read the original artile on Bloomberg, but didn't really understand all the details you guys here explained so well.

All I knew in my gut was that a man who was in charge of some rules was so unconfortable with the changing of rules b/c it is essentially gaming a already-broken system even more more, so he quit..

I am not a finance guy, but there is something about all this excessive money printing, changing rules.. well.. its like they are holding a crumbling system together. I don't understand why the dow and s&p is up.. but my gut says ... its not based on fundamentals, and there are bigger fish than me, an average american, who are gaming the system... and when the crash comes, they will be the first to leave, leaving little guys like me holding the bag.

I don't trust any of this.. so I am grateful to sites like yours for this information, and the explainations. thanks.

Anonymous said...

Balls out, great post.

HazeNYC said...

unemployment rate @ 8.5% which is IN-LINE with expectations.. RALLY! wooo!! all is well... our econonmists dismal consensus is reality!!

Concrete Jungle said...

You almost lost me when you quoted Jonathan Weil - he's a joke, and you've damaged your reputation by sourcing him. period. The "changes" Weil harps on, are part of the old rules - they're not even new. He's so lost, it's amazing he gets past an editor. The examples he used (common equity in AIG and FNM) are extremely liquid stocks, both with 8-digit average daily volumes - they wouldn't be affected at all by the rules. He also implies that there were two members who were dead against the proposals, but if you read the proposals their alternative view is included - they didn't just vote no. The primary part they disagreed with was that they felt that FASB should work with the IASB.

Have you read the changes? I'm no accountant, but they don't really change anything the way that I read them. Some changes are warranted (some aren't), but as you pointed out yourself a few weeks ago, the banks are already marking a lot of their holdings at par that obviously wouldn't trade at par in today's market. They aren't going to be able to mark them at a premium, so little effect there. The "illiquid" markets like CMBS are actually extremely liquid by many standards - it's not hard at all to determine market prices, so they don't even get factored into the FAS 157-e changes. Moving a loss to another line item doesn't affect the end analysis for someone buying a bank's stock (insert investment here), they just take the new line item into account when pricing/discounting the stock.

I'm genuinely curious as to what the big change is here?

watermelonz said...

how is valuing something based on some discounted cashflow method relying on a randomly chosen rate discounted at a constant rate a better valuation method than the market price discovery method (MTM). The reason why we have MTM is so we can rely on the market price determined by an aggregate group of buyers and sellers. The bottom-line is we F*cked up big time this time and let's not make this even more FUBAR.

These government fat-heads are trying to fix the financial system buy plugging up one hole at a time. When they stick their finger in one hole, another hole appears somewhere else and they try to plug that one with another finger. They will continue to stick their fingers into holes that pop up until one day they don't have enough fingers for all the holes that needs to be plugged.

God bless America!

Chris said...

Mark-to-Market Rule Gives More Clarity, Not Less: John M. Berry 2009-04-03 04:01:01.7 GMT

Commentary by John M. Berry
April 3 (Bloomberg) -- Mark-to-market accounting rules are being brought a little closer to economic reality -- accompanied by misplaced howls of outrage.
True, the ostensibly independent Financial Accounting Standards Board yesterday agreed to alter a portion of the rules only under extreme pressure from Congress, and that’s unfortunate. Still, the standards have forced many financial institutions to overstate losses on trillions of dollars worth of assets, intensifying the global financial crisis.
Defenders of the rules say they protect bank investors and changing them will allow institutions to hide future losses. To the contrary, they have helped drive down the value of bank stocks, made shorting the shares much easier and caused bank stockholders to lose hundreds of billions of dollars in such companies as Citigroup Inc. and Bank of America Corp.
William M. Isaac, a former chairman of the Federal Deposit Insurance Corp., told a House Financial Services subcommittee hearing on March 12 that “MTM accounting has destroyed well over $500 billion of capital in our financial system.”
Since capital can be leveraged about 10 times in making loans, the rules have “destroyed over $5 trillion of lending capacity,” said Isaac, now a consultant with the Secura Group of LECG Corp.
The problem with mark-to-market accounting is that it officially has presumed there’s a functioning market in whatever asset is being valued -- and that means a deal between a willing buyer and seller that isn’t being forced to sell. Actually, no such market exists for many mortgage-backed securities.

Distress Sale

Nevertheless, according to testimony at the March 12 congressional hearing, accountants have required many banks to calculate values based on distressed sale prices. That has meant large writedowns even on mortgage-backed securities that the institutions intend to hold to maturity.
Take the case of the Federal Home Loan Bank of Atlanta. Following the mark-to-market rules, it wrote down the value of its portfolio of mortgage-backed securities by $87.4 million in last year’s third quarter. Its actual projected loss on the
securities: $44,000. For the fourth quarter the bank recorded a further $98.7 million loss on the securities.
That result makes no sense when the bank doesn’t trade such assets. However, if the current market value declines significantly and stays down for an extended period of time -- a condition known as other-than-temporarily-impaired -- mark-to- market has been required, a bank spokesman said.
A writedown might still be required under the changes FASB approved yesterday. Yet auditors can now use “significant professional judgment” when valuing illiquid securities. That’s what they should have been allowed to do all along.

Cash Flow

The change will make it harder for accountants to continue to protect themselves from lawsuits by using some trade, no matter at what low price, to determine a security’s value.
With the new leeway, the Atlanta bank should be able to value its mortgage-backed securities by calculating the expected cash flow -- the monthly mortgage payments from homeowners -- and applying an appropriate discount. That’s the approach the bank used to determine the $44,000 third-quarter loss.
The key points in this example are that almost all the mortgages involved are still performing and the bank plans to hold the securities to maturity -- and yet large writedowns were required.
Think of it this way. There are millions of U.S. homeowners who are “underwater” with their mortgages. That is, they owe more than the value of the home in today’s depressed housing market.

Putting Up Money

That’s hardly good news, and it might make it impossible to refinance the mortgage because of the lack of equity.
On the other hand, the house hasn’t changed. It’s still providing the same shelter and other amenities to the household, and if the family’s financial circumstances haven’t gone into a tailspin, the monthly mortgage payments can still be made.
The family doesn’t have to put up money to cover the difference between the mortgage and the lower market value. Nor should the Atlanta bank have to take a big hit on its reported income because some other mortgage-backed securities owner sold in a depressed market.
FASB wisely backed away from a tentative proposal to allow auditors to assume that limited trades in an inactive market were always distressed sales. That would have gone too far.
Now accountants are supposed to use their judgment in assessing the meaning of such trades. That’s a big improvement over just using the last transaction price, as many auditors have been doing.

Recovering Writedowns

Now FASB has to deal with how banks deal with recoveries of previous writedowns due to other-than-temporary-impairment losses when there’s evidence that loss is no longer there.
A March 27 letter sent jointly by the five federal regulators of financial institutions -- the Comptroller of the Currency, the Federal Reserve Board, the Federal Deposit Insurance Corp., the National Credit Union Association and the Office of Thrift Supervision -- urged FASB to add such a recovery to current earnings.
Since the losses were subtracted from earnings, that would be an equitable way for FASB to go -- and soon.

(John M. Berry is a Bloomberg News columnist. The opinions expressed are his own.)

Anonymous said...

Please provide instructions for participating in Project Mayhem.

Unknown said...

For my Accounting research paper I will use your statistics that the year-end balance sheet at the FHLBank of Seattle, for example, showed $5.6 billion of non-government mortgage-backed securities that it says it will hold until maturity.