Banks want to shoot the messenger over fair value rules
By Lynn Turner
02 October 2008
Transparency is critical to gaining investors’ trust in markets. Unless information is accurate and reliable, investors will not trust it. When investors are given misleading or incomplete information, they rightfully steer clear of investing in the markets because all too often it leads to losses.
Nonetheless, bankers are once again asking for a suspension of accounting rules that require them to report what their assets are worth, including declines in values when they occur. This comes at a time when the International Monetary Fund and Bridgewater Associates have reported that mortgage-related losses will balloon to between $945bn and $1,600bn. But with institutions only reporting a little more than $500bn in losses to date, it is apparent that more losses should be forthcoming if data from the banks are reliable. To suspend further reporting of these to investors and depositors is akin to a student asking for suspension of a report card when a failing grade is coming.
The reality is that the bankers are trying to shoot the messenger. They loaned out more cash than they are now collecting. If you make a loan for $100 but only get back $60, that is a problem. But when you do this repeatedly, using money borrowed in the first place, it becomes a crisis as banks run out of cash. It is the same thing that happens at home when month after month you spend more than you get in your paycheck.
But if bankers tell investors they have assets worth $100 when they are only worth $60, they will be telling a lie, lose the confidence of investors, and buyers for their stock will evaporate. Bankers counter that the markets are depressed and the assets are worth more because of a lack of liquidity and buyers. But the real problem is the assets are priced higher than what buyers are willing to pay – as we saw at Wachovia and Washington Mutual. Given the risks of these loans, many will never be collected in full. Even the banks won’t buy them from one another because they would incur losses – as we saw at Lehman.
Buyers will only emerge when the assets are offered for sale at a price that will generate a reasonable return, given the risk involved. Unfortunately, this means the banks will need to take the additional losses, unless taxpayers bail them out. These are losses for which bank management should be held responsible and accountable, yet they are trying to shove them under the carpet.
The real crisis is that banks have run out of sufficient cash to remain liquid, pay off depositors and other bills as they come due. Even if fair value reporting is suspended, the crisis will remain. Whether a bank reports an asset on its books at $100 or $60 does not change its available cash or the amounts it owes. That is why even if fair value reporting is suspended, the crisis will remain. If the problem were merely fair value accounting – as banks argue – then they would not need the $700bn they are lobbying for. However, even with suspension of fair value accounting, they are still asking for all the money – hoping their red herring will deflect attention from the real problem.
That is not to say accounting rules aren’t in need of serious repair. The US Financial Accounting Standards Board and the International Accounting Standards Board get a failing grade for permitting companies to treat financings as off balance sheet, a deficiency they were well aware of. At the same time, FASB Standard No 157, which does not require fair value accounting, but does tell one how to calculate those values and requires much greater transparency on the quality and values of assets, has greatly enhanced transparency.
To bring back investors to the markets, they must once again be convinced they are getting reliable information upon which to base informed, not misinformed decisions.
Until then, they may prefer Las Vegas where at least the word “Casino” appears on the entrance.
Lynn Turner is formerly chief accountant at the Securities and Exchange Commission