AIG mostra recuperação 3

outubro 8, 2008
AIG: Days after $85bn rescue, insurer hosted banquets
Andrew Clark New York
8 October 2008

The Guardian

6

The world’s largest insurance company, AIG, spent $440,000 on a lavish corporate retreat at one of California’s top beachside resorts a few days after accepting an $85bn emergency loan from the US government to stave off bankruptcy.

Details of the week-long getaway enraged legislators at a congressional hearing yesterday where AIG’s former bosses were accused of spending taxpayers’ money on pedicures, golf games and cocktails.

Crippled by losses on financial insurance companies, AIG was bailed out by US taxpayers on September 17 to avert a collapse which risked causing further failures.

The House oversight committee, which is investigating the company’s problems, confronted AIG executives with an invoice from the St Regis resort in Monarch Beach, south of Los Angeles, detailing an eight-day company event which began five days after the rescue.

“Average Americans are suffering economically,” said Henry Waxman, chairman of the committee. “They are losing their jobs, their homes and their health insurance. Yet less than one week after the taxpayers rescued AIG, company executives could be found wining and dining at one of the most exclusive resorts in the nation.”

The bill shows that AIG spent $139,375 on rooms, $147,301 on “banquets”, $23,380 on spa treatments and $6,939 on golf at an eight-day company event which began on September 22.

“US taxpayers will be, in effect, paying for this,” said Elijah Cummings, another Democrat, who demanded to know who was responsible for the outlay. “I think that person ought to be fired.”

Rates for the 325 rooms at the resort are typically upwards of $500 a night and the travel guide Fodor’s gives the place a rave review, saying: “Exclusivity and indulgence carry the day here; you can even have someone unpack for you.”

AIG has defended the event, saying it was to entertain freelance insurance salesmen who sold life, health and accident policies for the group’s US subsidiary.

But former chief executive Robert Willumstad, who stood down as a condition of the government’s bail-out, conceded that the getaway “seems very inappropriate”.

“If I had been aware of it, I would have prevented it from happening,” he added.

Defending their conduct in AIG’s final days, Willumstad and his British-born predecessor, Martin Sullivan, blamed the company’s problems on accounting rules which required it to write off billions of dollars on mortgage-related securities.

Sullivan said these rules had “unintended consequences” in making AIG’s books look worse than they actually were against the backdrop of a “financial tsunami”.

Carolyn Maloney, a Democrat from New York, accused the two executives of blaming accountants for AIG’s difficulties when in fact they had been “wrecking a great company” by gambling on obscure derivatives. “I think you should apologise to the American people for your mismanagement,” she said.

“Looking back at my time as CEO, I don’t believe AIG could have done anything differently,” said Willumstad. “The market seizure was an unprecedented global catastrophe.”

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AIG mostra recuperação 2

outubro 8, 2008
A.I.G. Takes Its Session In Hot Seat
By MICHAEL J. de la MERCED and SHARON OTTERMAN
8 October 2008

The New York Times

Late Edition – Final
1

A day after Richard S. Fuld Jr. was compelled to explain the millions of dollars he made at Lehman Brothers, two former executives of the American International Group took their turns in government witness chairs on Tuesday, answering critical questions from lawmakers about business and pay practices and outsize spending that continued even after the company received an $85 billion lifeline from the government.

One particular point of contention during the hearing before the House Oversight and Government Reform Committee was a weeklong retreat that a life insurance subsidiary, AIG General, held for its top sales agents at the St. Regis Resort in Monarch Beach, Calif., only a week after the government extended its $85 billion loan last month.

The $442,000 in expenses for the week included $150,000 for food and $23,000 in spa charges, according to documents obtained by the committee.

Joe Norton, A.I.G.’s director of public relations, said in an interview that the event had been scheduled last year, though he did not know whether executives had considered canceling the retreat after the bailout.

In addition to questions about spending, the two A.I.G. executives who appeared before legislators, Martin J. Sullivan and Robert B. Willumstad, faced sometimes heated inquiries into risky bets by the company on complicated financial products that insured mortgage-backed securities.

A.I.G., for decades the largest insurance company in the world, must now sell wide swaths of its businesses to repay the government loan, made because of the potential catastrophe that the company’s bankruptcy would have unleashed.

Mr. Sullivan was criticized for his reassurances to investors about A.I.G.’s health in December despite warnings from company auditors that its exposure to those contracts was growing.

And many legislators berated the two men for large pay packages dispensed to top executives despite evidence that the company’s financial health had begun deteriorating in 2007. Mr. Sullivan was questioned by several lawmakers over why he had requested that accounting losses from A.I.G.’s exposure to these swaps be excluded from calculating one particular compensation plan.

The two former executives also took criticism from their outspoken predecessor, Maurice R. Greenberg, who sought to deflect responsibility in a statement to the committee. Yet Mr. Greenberg, who also questioned the need for the government’s de facto takeover of the company as part of its rescue package, declined to appear, citing illness.

The nearly five-hour hearing was the second this week held by the House committee after the pointed questioning on Monday of Mr. Fuld about the collapse of Lehman, the investment bank he led. Committee members, led by Henry A. Waxman of California, are seeking more information from troubled financial companies after the passage of the Bush administration’s $700 billion bailout plan last week and the chaos gripping the markets.

”A.I.G. had to be bailed out by taxpayers because of your investments in credit-default swaps,” Carolyn Maloney, Democrat of New York, said. ”I don’t believe any of your management deserves a bonus.”

Mr. Sullivan, who was ousted as A.I.G.’s chief executive in June, and Mr. Willumstad, who was the company’s chairman before succeeding Mr. Sullivan, blamed wider market tremors for the company’s stumbles. They also attributed A.I.G.’s $25 billion in write-downs to mark-to-market accounting rules, which forced the company to take paper losses that led to debilitating credit downgrades.

Yet both Democratic and Republican lawmakers dismissed those arguments, citing testimony from a former chief accountant for the Securities and Exchange Commission.

”A.I.G. is blaming its downfall on accounting rules which require it to disclose losses to its investors,” the witness, Lynn E. Turner, said. ”That’s like blaming the thermometer, folks, for a fever.”

Instead, lawmakers focused on efforts by company management to shield inquiries into the London subsidiary that had underwritten the derivatives contracts that became devalued during the global credit crisis.

Both PricewaterhouseCoopers, the company’s auditor, and an independent accountant complained of a lack of access to the London unit and its leader, Joseph Cassano. The accountant, Joseph St. Denis, said in a statement to the committee that he had been deliberately blocked from questioning Mr. Cassano because he might ”pollute the process.” Mr. St. Denis later resigned in protest.

Mr. Cassano has continued to draw $1 million a month in consulting fees from A.I.G., a fact that aroused ire from several lawmakers. He earned $280 million over the last eight years.

For his part, Mr. Greenberg sought in his written statement to cast A.I.G.’s troubles as arising after he left in 2005, under the shadow of an accounting inquiry.

”When I left A.I.G., the company operated in 130 countries and employed approximately 92,000 people,” Mr. Greenberg said in a statement. ”Today, the company we built up over almost four decades has been virtually destroyed.”

When asked about Mr. Greenberg’s contention that risk controls at A.I.G. had loosened after his departure, Mr. Sullivan argued that risk controls had actually tightened since then.

AIG mostra recuperação

outubro 8, 2008
AIG Spa Trip Fuels Fury on Hill; Pressing Executives to Concede Mistakes, Lawmakers Blast Them About Bonuses
Peter Whoriskey
Washington Post Staff Writer
8 October 2008

The Washington Post

FINAL
D01

For some people at AIG, the insurance giant rescued last month with an $85 billion federal bailout, the good times keep rolling.

Joseph Cassano, the financial products manager whose complex investments led to American International Group‘s near collapse, is receiving $1 million a month in consulting fees.

Former chief executive Martin J. Sullivan, whose three-year tenure coincided with much of the company’s ill-fated risk-taking, is receiving a $5 million performance bonus.

And just last week, about 70 of the company’s top performers were rewarded with a week-long stay at the luxury St. Regis Resort in Monarch Beach, Calif., where they ran up a tab of $440,000.

At a House committee hearing yesterday, Rep. Henry A. Waxman (D-Calif.) showed a photograph of the resort, which overlooks the Pacific Ocean, and reported expenses for AIG personnel including $200,000 for rooms, $150,000 for meals and $23,000 for the spa.

“Less than a week after the taxpayers rescued AIG, company executives could be found wining and dining at one of the most exclusive resorts in the nation,” Waxman said in kicking off an angry hearing of the House Committee on Oversight and Government Reform. “We will ask whether any of this makes sense.”

“They were getting their manicures, their pedicures, massages, their facials while the American people were paying their bills,” thundered Rep. Elijah E. Cummings (D-Md.).

The gathering was planned before the bailout as a reward for life insurance agents, a company spokesman said, and fewer than 10 AIG executives were present.

The hearing promised and delivered strident condemnations of the two AIG executives the committee had invited to testify. Sullivan served as chief executive from 2005 to 2008; Robert B. Willumstad served as chief executive from June until September, and before that was chairman of the board.

“Shame on you, Mr. Sullivan,” said Rep. Jackie Speier (D-Calif.), noting that Sullivan was not giving up any of his $5 million performance bonus.

Over and over, the committee members vented outrage at having the federal government bail out the company, referring frequently to their angry constituents.

But neither Sullivan nor Willumstad acknowledged making any mistakes.

“Looking back on my time as CEO, I don’t believe AIG could have done anything differently,” Willumstad said.

Sullivan blamed “a global financial tsunami” and the “mark-to-market” accounting rules, which require businesses to value assets at market value, even if no sale is imminent.

“I have spent my entire adult life in service to AIG, and I am heartbroken at what has happened,” he told the committee.

The committee members, barely concealing their frustration, seemed stunned by the duo’s refusal to find fault with their own performances.

“Don’t you think the management has some responsibility for what went on there?” Rep. John F. Tierney (D-Mass.) said at one point, his voice incredulous.

Sullivan responded that when they learned there was trouble with their investments, they put controls in place.

Tierney then questioned whether, at their compensation levels, the manager should have been “ahead of the curve” on such troubles.

“This is a fundamental failure of management,” Tierney said, exasperated.

The executives sat stone faced.

The House committee, which took on executive compensation at bankrupt Wall Street firm Lehman Brothers on Monday, has received “tens of thousands” of pages of documents from AIG, Waxman said.

Those documents show that AIG executives may have played a more significant role in the company’s collapse than either of the two executives let on, Waxman said.

On Dec. 5, 2007, Sullivan told investors “we are confident in our marks and the reasonableness of our valuation methods.”

But just a week before, PricewaterhouseCoopers, AIG’s auditor, had warned Sullivan that the company “could have a material weakness relating to these areas,” according to minutes from the company’s audit committee.

Moreover, as early as March federal regulators blamed lax management.

“We are concerned that the corporate oversight of AIG Financial Products . . . lacks critical elements of independence, transparency and granularity,” the Office of Thrift Supervision wrote to the company on March 10.

Just as frustrating to the committee members, Sullivan and Cassano seemed to have been rewarded for their performance, even though the company plunged under their stewardship.

AIG lost more than $5 billion in the last quarter of 2007 because of its risky financial products division, Waxman said.

Yet in March 2008 when the company’s compensation committee met to award bonuses, Sullivan urged the committee to ignore those losses, which should have slashed bonuses.

But the board agreed to ignore the losses from the financial products division and gave Sullivan a cash bonus of more than $5 million.

The board also approved a new contract for Sullivan that gave him a golden parachute of $15 million, Waxman said.

As for Cassano, the executive in charge of the company’s troubled financial products division, he received more than $280 million over the past eight years. Even after he was terminated in February as his investments turned sour, the company allowed him to keep as much as $34 million in unvested bonuses and put him on a $1 million-a-month retainer.

He continues to receive $1 million a month, Waxman said.

Asked why they didn’t fire Cassano, Sullivan said they needed to “retain the 20-year knowledge of the transactions.”

“What would he have had to have done for you to fire him?” Waxman said.

Contabilidade não é a culpada

outubro 8, 2008
A bad time to loosen accounting standards; Deregulation like treating a patient with poison
Al Rosen-Financial Post -8 October 2008

National Post – FP11

How does it happen that the CEO of one of Canada’s largest companies decides to focus his ire, in the most tumultuous of markets, on something that most regard as interesting as drying paint?

Last week, Manulife Financial CEO Dominic D’Alessandro launched into a five-minute impromptu “sermon” during the company’s investor day, in which he said current accounting rules were “absolutely nuts” and “make no sense for anybody.”

Mr. D’Alessandro said he believes that unchecked, the ultimate outcome, among other problems, will be higher insurance costs for everyday Canadians.

He is not alone in believing that accounting rules have contributed, or even caused, the current financial crisis. In fact, the very next day the SEC issued a memorandum to corporate accountants attempting to rein in volatile financial reporting, and the billion-dollar headline losses it was spawning.

Following that, U. S. accounting standard-setters held an emergency meeting to issue new guidance on the subject.

So did accounting cause the current financial mess? The short answer is no. The long answer is that it’s a symptom of a larger push toward deregulation that did cause the current crisis, and therefore, it still needs addressing over the longer term in both the United States and Canada.

But let’s rewind for a minute. The accounting in question focuses on so-called fair value rules. Recent changes in the United States have required companies to value obscure and arcane financial instruments that are occasionally unique unto themselves. In these instances, and this is to simplify, the predictive power of the models used to value the instruments has been thrown into question because of the massive changes taking place in the market.

On top of that, companies have also had to value less obscure assets, but for which there are currently no liquid markets. Essentially, companies having been marking-to-market assets (and recording losses) for which the latest transactions have been distressed sales, which are arguably not a reflection of fair value for other holders of similar assets.

This has created somewhat of a tail wagging the dog scenario, and in fact, led to the inclusion of Sections 132 and 133 in the Emergency Economic Stabilization Act passed in the United States last week. Those sections allow the SEC to suspend fair value accounting for any issuer or transaction it deems necessary, and requires them to investigate the impact of the rules, in concert with the Fed and Treasury, and report back to Congress in 90 days. Interesting times for accounting indeed.

However, the issue at its core goes far beyond the current financial mess. In fact, like many aspects of the crisis these days, the solution could end up exacerbating the problem over the longer erm. Should the SEC and FASB relax the fair value rules, they will essentially do it by injecting more management leeway into the process.

That same push for greater management wiggle-room is the theme that lies at the heart of the move towards International Financial Reporting Standards. Indeed, the notion of fair value accounting is set to expand greatly with the introduction of International Financial Reporting Standard (IFRS) in Canada. If you thought marking-to-market financial assets caused confusion, wait until the value of inventories, real estate, capital assets and more are also jiggered at the end of every reporting period.

However, we should not forget the actual issues that led to the current financial crisis, including massive deregulation in many areas. Much of the criticism for that deregulation, including the lifting of reserve requirements and the voluntary supervisory program of the now failed investment banks, is being placed at the feet of the SEC, and its current chairman Chris Cox.

Thus, even though Mr. Cox is a Republican appointee, GOP presidential hopeful John McCain has already called for his head. And in an ironic twist, it was Mr. Cox who has generally been regarded as leading the push towards the potential U. S. adoption of IFRS, which is the accounting version of deregulation squared.

Thus, suspending or modifying the fair value rules at this point is akin to treating the symptoms of a disease with the poison that caused it. While mark-to-market losses make the situation look worse than it is, there are plenty of real economic losses that were caused by greedy bankers, faulty risk protections, and consumer spending gone wild.

In the end, the accounting is not the cause of the crisis, but it still needs considerable fixing, because it is also the product of a deregulated environment that is the real cause of such great pain for investors.

-Al Rosen is a forensic accountant at Accountability Research Corp.,

Uma análise da crise

outubro 6, 2008

Banks want to shoot the messenger over fair value rules
By Lynn Turner
02 October 2008
Financial Times
Asia Ed1
15

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

Extintor ou gasolina?

outubro 6, 2008

Mistakes Of the Past Live Again
FLOYD NORRIS
03 October 2008 – The New York Times – Late Edition – Final – 1

 

”Reality is bad enough. Why should I tell the truth?” — Patrick Sky, songwriter

As the ideas fly for saving the financial system, it is amazing — and appalling — how many of them seem to be straight out of the playbook from the savings and loan crisis.

Then, as now, Congress decided to reassure investors by more than doubling the amount of deposits that could be insured. Then, as now, legislators put pressure on regulators to change accounting rules to make the financial institutions look healthier than they were.

”It turned a $25 billion problem into a $350 billion problem,” said Robert R. Glauber, who was under secretary of the Treasury from 1989 to 1993 and put together the Resolution Trust Corporation, which eventually sold off all the bad assets the government received from failed savings and loan associations.

The raising of the deposit guarantee limits in 1980 to $100,000, from $40,000, made depositors less concerned about the health of their institution, and made it easier for dying institutions to attract deposits. Raising the figure to $250,000 now could have the same effect.

In 1981, regulators allowed troubled savings and loans to issue pieces of paper with the Orwellian name of ”income capital certificates.” In fact, the thrifts had neither income nor capital, but the certificates allowed them to pretend they were solvent. That let them stay in business for years to come, during which time they could gamble, and lose, much more money.

Now banks and legislators are pushing for a change in accounting rules to end mark-to-market accounting for financial assets. They are sure that market values are too low, so why not just assume they are really higher?

That illogic has caught on, particularly among Republicans. The bailout bill calls for a study of the damages caused by mark-to-market accounting, and invites the Securities and Exchange Commission to suspend the rule.

Apparently in response to that pressure, Christopher Cox, the chairman of the S.E.C. and a former Republican congressman, put out a clarification of the rule that might have persuaded all sides that he stood with them.

The American Bankers Association concluded that he had slapped down auditors who were forcing banks to unreasonably reduce the value of assets no one was buying. Some accountants thought the statement would not change anything. Auditors cringed, awaiting appeals of clients to let them value assets as they please. They worried more when they learned that Mr. Cox wanted to meet with the heads of all the big accounting firms, something he will do on Friday.

This may yet prove to be a brilliant move from the most political — and least market-oriented — S.E.C. chairman I can remember. It could persuade Congress not to make things worse, and not really give the banks new permission to fudge their books. But even if that happens, it has reinforced the impression that this S.E.C. responds to political pressure, and that is not good. Told that I was writing about political influence and the S.E.C., Mr. Cox declined to be interviewed for this column.

The accounting furor came only weeks after the S.E.C. hurriedly put limits on short-selling, and then increased them. The toughening of the rules came hours after Senator John McCain, the Republican nominee for president, said Mr. Cox should be fired because he had not done enough to protect companies from short-sellers.

Whatever the virtue of those rules, the fact that few people, in or out of the S.E.C., were consulted before they were issued led to a series of amendments and made the commission appear disorganized.

It was almost 8 p.m. Wednesday — the evening before the short rules were to expire — by the time the commission announced it would extend them. Now you cannot sell financial stocks short until Oct. 18, or three days after the bailout legislation is passed, whichever comes first.

Mr. McCain chose to get involved in the accounting fight as well, but this time he praised the commission. ”John McCain is pleased to see that the S.E.C. has finally decided to permit alternative accounting methods to mark-to-market accounting for securities where no active market exists,” his campaign said after the S.E.C. interpretation was issued, taking for granted that the bankers had prevailed.

”There is serious concern that these accounting rules are worsening the credit crunch, making it difficult for small businesses to stay afloat and squeezing family budgets,” the statement, attributed to a McCain adviser, Douglas Holtz-Eakin, continued. ”In March, John McCain called for a meeting of accounting professionals to discuss whether mark-to-market accounting was magnifying problems in the financial markets.”

This is the same Mr. McCain whose Senate career was nearly derailed by his involvement in the savings and loan scandal, when he and other senators forced meetings with regulators in a successful effort to avoid the seizure of Lincoln Savings, a thrift controlled by Charles Keating, who was a major contributor to the senators. The argument then was that Lincoln was sound, despite the numbers.

Lincoln‘s eventual failure cost the government $2 billion, far more than it would have cost had regulators acted sooner.

Mr. McCain has said that the ”Keating Five” scandal showed him the dangers of loose campaign financing laws. It evidently did not show him there was any danger in calling for lenient accounting rules to beautify bank balance sheets.

It is possible, perhaps probable, that many mortgage securities are undervalued now, amid the kind of uncertainty and fear that caused investors to doubt whether AAA-rated General Electric was really safe. But the solution is not to give the banks a new license to print the numbers they choose. ”Sophisticated institutions are afraid to trade with each other,” Mr. Glauber said, ”because they don’t believe each other’s balance sheets.”

To get them to believe will require a lot of capital to be injected. The plan from Henry M. Paulson Jr., the Treasury secretary, calls for the government to buy securities from banks for more than current market value but less than the government hopes they will be worth someday.

Whether it will succeed depends in part on whether banks conclude that other banks are solvent after the money arrives and the dodgy securities depart.

On Thursday, as the politicians considered whether to push for bad accounting, the International Monetary Fund issued a report on financial crises around the globe. One part had recommendations for government action:

”Speed is of the essence to minimize the impact on the real economy,” wrote Luc Laeven, an I.M.F. economist.

”Too often,” he added in what could have been a description of how the S.&L. crisis was mishandled, ”regulatory forbearance and liquidity support have been used to help insolvent financial institutions recover — only to have it become clear later that delaying decisive intervention increased the stress on the financial system and the economy.”

To avoid that mistake, he said, ”policy makers should force the early recognition of losses and take steps to ensure that financial institutions are adequately capitalized.”

Patrick Sky was one of my favorite singer-songwriters in the 1960s. I don’t think the bankers have licensed the song quoted at the top of this column, but it would be an appropriate choice.

Personally, I think it is foolish for the banks to mount this campaign. It will raise more questions about the value of their assets when many investors — as well as the banks themselves — already doubt the numbers.

But these are the same banks that got into this mess by creating and buying the toxic securities that they now claim are worth more than they will pay for them. Foolish decisions from such institutions should not come as a surprise.

Sobre a Contabilidade e a Crise 10

outubro 3, 2008

Strange Bedfellows: Fair Value and the Bailout Plan

The presence of the government in the market could be just another piece of information to assess.
David M. Katz and Tim Reason, CFO.com | US
October 2, 2008

Contrary to many incorrect media reports, the guidance on fair-value accounting issued on Tuesday by the Securities and Exchange Commission and the Financial Accounting Standards Board wasn’t intended as another nail in the coffin of fair-value accounting.

Rather than responding to the growing cries by banks and legislators to suspend mark-to-market reporting, FASB and the SEC were merely clarifying their previously held position that FAS 157, the now controversial fair-value disclosure standard, should be applied with an eye toward broad principles, rather than rigid rules, at least one valuation expert suggests.

It was that rigid interpretation—and not the fair-value standard itself—that may have helped intensify the financial crisis by moving financial CFOs and auditors to price distressed assets much lower than they needed to, David Larsen, a managing director with Duff and Phelps, told CFO.com.

Because of the lowered valuation of their assets, banks might have felt impelled to tighten lending, the theory goes. To be sure, the language of 157 may have tilted them toward lower asset pricing, according to the valuation expert.

The standard, titled Fair Value Measurement, defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” That price is also referred to as an “exit price.” In the current market for distressed mortgage assets, as spreads have widened between the asking and bidding prices, “the exit-market concept of 157 inherently pushes one toward the bid price because that’s what the market is offering,” Larsen says.

Thus, he adds, some issuers have placed too much emphasis on the price they sold their last securities they bought or sold as markets were freezing up, rather than also incorporating the instrument’s cash flows and risk portfolios in the valuation. Perhaps responding to that issue, the SEC and FASB declared in their guidance that, while transactions in inactive markets “should be considered in management’s estimate of fair value,” such deals aren’t “determinative.”

Earlier in the guidance release, the standard-setters state that “when an active market for a security does not exist, the use of management estimates that incorporate current market participant expectations of future cash flows, and include appropriate risk premiums, is acceptable.” They add: “The determination of fair value often requires significant judgment.”

Such a principles-based approach to compliance was the intent of the standards-setters even before Tuesday’s guidance, contends Larsen, who is a member of FASB’s Valuation Resource Group.

Months before the guidance, both FASB and participants at a summer SEC roundtable indicated that “just because there’s been a single transaction in an illiquid market, you don’t necessarily have to record that as your fair value,” he said. “But because that [interpretation is] out there, many people have latched onto that.”

In fact, Larsen noted, accounting literature actually provides issuers with the flexibility to look at the asset’s underlying cash flows and its true risks, as well as the last transaction price: “Whereas the bid may be 20 and the ask may be 90, maybe a more fair representation [of fair value] may be something like 60.”

The fear of litigation, however, may have led to lower valuations. “It’s the rules-based nature of the historic audit profession and the historic CFO profession running kind of head on into the principles-based concept of 157,” he said. “If an auditor doesn’t follow the rules, they get beat up by their regulator, but 157 is principles-based, so it clearly allows judgment.”

Rick Nathan, managing director of Trenwith Valuation LLC, speaking with CFO.com before the SEC and FASB issued new guidance, said he thinks banks were “overly conservative” in their valuations, relying too heavily on market prices in a market that essentially didn’t exist. “As a consequence, they are really hurting investors, and, by extension, taxpayers.”

While FAS 157 “is not completely infant in use, it’s still not very well understood in terms of balancing the various choices one has,” says Nathan — a view apparently confirmed by FASB’s new guidance. And banks aren’t the only ones taking the wrong approach. “You have auditors who are trying to determine fair value on a fairly current basis,” Nathan says.

The standard lays out a so-called measurement “hierarchy” that provides ways to value securities depending on how liquid they are. Regularly traded securities (Level 1) are valued on their selling price, whereas securities that are thinly traded (Level 2) or in illiquid markets (Level 3) have a different set of inputs. “These mortgage-backed securities are Level 3-based securities, and one is not forced to rely on the last price or on recent transactions,” Nathan explains. “There should be more patience and more exploration into what FAS 157 allows without fear that the last-traded price is the best determination in the eyes of the commission or shareholders.”

With a second House vote on the Congressional rescue package passed by the Senate yesterday expected by the end of the week, however, the question of how well fair value can coexist within an increasingly government-controlled financial system is still up in the air. Mark-to-market opponents contend, of course, that there can be no such thing as “fair value” in a market dominated by the government. What kind of “market participant” could the federal government be, if it sets out to pay banks higher than market prices for distressed assets, as the plan envisions?

“A highly unusual, unanticipated market participant,” but one that the FAS 157 valuation regime could still accommodate, thinks Larsen. To be sure, the government could be a participant with “ulterior motives,” and non-governmental asset holders would do well to view the effects it has with “some level of questioning,” he said.

But the nature of the financial instrument being bought and sold remains the same, he says, and the fact that the government is involved should be treated just another piece of information in valuing the assets.

Contending that fair-value accounting has led banks to dump distressed securities into the market at fire-sale prices, some have floated the notion that a bailout plan should include a suspension of the use of mark-to-market accounting of perhaps two years. Larsen wasn’t having any of it. “A moratorium on mark-to-market accounting doesn’t make sense conceptually. If you, say, suspend application of 157, the only impact that would have would be potentially less disclosure on how values are being determined,” he says.

Further, having been provided with added disclosures under 157, investors might not enjoy having it taken away from them. “How would they react to having less information than they’ve had?” he asked. “How does less transparency help?”

Nathan also opposes those who argue for suspending fair value. “I think that’s a cop out,” he says. “I don’t think people are really looking into the spirit of FAS 157, and they are blaming 157. No one said it’s easy.”

Nathan is not a fan of the proposed bailout, objecting in particular to a provision which requires the Secretary of the Treasury to hold reverse auctions to buy distressed securities. “It might be easy to do a reverse auction, and it might be faster and it might be a transparent mechanism, but that doesn’t mean it’s the right solution,” he says.

The reverse auctions proposed under the bailout plan would provide an “observable price,” he acknowledges. But that won’t change the fact that the securities need to be valued as Level 3, in which the bailout’s price would still be just one of many valuation factors to be considered. “In a reverse auction, you are artificially creating a market as opposed to letting free forces create that market,” says Nathan.

For his part, Larsen feels that a government bailout could be an efficient way to activate the credit markets. To be sure, the criteria for judging the potential for success of any bailout proposal will be in the details. Overall, however, the core of the original plan submitted by U.S. Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke–buying distressed mortgage-backed securities at above-market rates from banks, which would then use the excess capital to begin lending money again–is solid, according to Larsen. The valuation specialist says, for instance, that if the government pays $40 per share for an instrument recorded on a bank’s books at $20 per share, the bank gets $20 of additional capital.

Depending on the leverage it can get, the bank could borrow 10 to 15 times that $20 of liquid capital and use it to provide “$200 of additional liquidity, or borrowing capacity, to the marketplace,” he said, noting that under such circumstances, “the bank’s balance sheet doesn’t just look better, it’s really is better because [it’s] just changed that $20 of illiquid assets for $40 of cash.”

Sobre a Contabilidade e a Crise 9

outubro 3, 2008

Coming Very Soon: Fair Value Illustrated

FASB breaks with procedure to push out additional fair value guidance, which it plans to issue by next week.
Marie Leone, CFO.com | US
October 1, 2008

The Financial Accounting Standards Board will break with procedure and issue new guidance on fair value accounting after only a seven-day comment period. The additional guidance will provide a concrete example of how companies should value illiquid assets under the fair value accounting method described in FAS 157, the rule related to fair value measurement.

The five-member board voted unanimously on Wednesday to issue a staff proposal that contains the example. The accelerated comment period will likely end on October 9, and FASB’s plan is to have the board finalize the draft at its meeting on October 10. When finalized and issued, the guidance will go into effect immediately.

By issuing an illustrative example, the board hopes to quell the controversial issue of how to measure the value of a financial asset under FAS 157 when no market exists for the asset. The additional guidance follows yesterday’s clarification released by FASB and the Securities and Exchange Commission, to reiterate that companies with illiquid financial assets are allowed to use management assumptions — including expected cash flow projections — in their fair value analysis.

The guidance comes amid a swelling chorus of calls from bank lobbyists, trade groups, lawmakers, and the Bush Administration to suspend fair value accounting. Indeed, the bailout bill defeated on Monday in the House of Representatives included sections giving the Securities and Exchange Commission power to suspend mark-to-market accounting “for any issuer” and to launch a probe into the question of whether it contributed to the crisis.

Those who blame fair-value accounting as either a cause or an accelerant in the current financial crisis do so because it forces banks forced to write down the values of illiquid securities. That in turn, has compromised both their balance sheets and their regulatory capital ratios, affecting their actual or perceived ability to lend. Defenders of fair value counter that the accounting simply exposed serious problems with bank investments, and that suspending it would be the equivalent of ignoring those problems, as Japanese banks did during their so-called “lost decade.”

FAS 157 provides a measurement hierarchy that provides ways to value securities depending on how liquid they are. Regularly traded securities are valued on their selling price, where as securities that are thinly traded or in illiquid markets have a different set of inputs. In practice, however, many experts suspect that banks and financial institutions gave undue weight to the last observable selling price of their securities before the markets froze completely.

“We are just elaborating on the brief release that was issued yesterday,” noted FASB member Leslie Seidman at today’s meeting. She said the decision to issue extra guidance in the form of an example is a way of publishing authoritative accounting literature that cross references the paragraphs of FAS 157 that address the measurement of illiquid assets.

“We cannot overemphasize that [the proposal] does not change the objective of FAS 157 regarding the market participation rule,” added George Batavick, another FASB member.

The example will include clarification on how companies should use the prescribed measurement hierarchy that separates assets and liabilities into three categories based on risk-related criteria. That hierarchy looks like this: Level 1 inputs are assets and liabilities that are measured using quoted prices in active market; Level 2 inputs, can be measured using other observable inputs, such as instruments that are marked to a model; and Level 3 inputs — considered unobservable — are thinly-traded assets and liabilities that are measured using estimates based on the value the company believes a hypothetical third party would pay for them.

The guidance issued yesterday by the FASB and the SEC will be included in next week’s staff proposal, and will apply not just to banks, but to all companies that use generally accepted accounting principles. It will explains that if a market for a security does not exist, a company may use a combination of factors to produce a fair value estimate of the securities. That means, for instance, that banks could work up an estimate by looking at expectations of future cash flows in combination with appropriate risk premiums related to default or liquidity risk, for example.

FASB board member Lawrence Smith says that he hopes the example serves to eliminate the question of whether “a good level 3 input trumps a bad level 2 input.” Smith contends that the question is flawed, because if the level 2 inputs are “bad,” then the company should not have been using them in the first place. “Whether the market goes up or down, [companies] should consider the changes in the marketplace . . . and include those trends in the models used to determine today’s fair value,” opined Smith.

“I know [illiquid markets] are more pervasive now, but it is not a new problem,” asserted FASB member Thomas Linsmeier. “We have been dealing with inactive markets for years.”

The proposal will be “very fact specific” and stress the use of judgment in the example, said FASB chairman Robert Herz, who also noted that the draft will only consider assets, and not the treatment of liabilities under FAS 157. Herz made a point of noting that the accelerated comment period was in response to an “unprecedented period,” referring to the current credit crisis, and is not aimed at squelching comments from market participants.

In general, board members were adamant about conveying to financial statement users, preparers and auditors that the new guidance does not change FAS 157 or suspend the use of fair value accounting for financial instruments.

Herz, adding a personal note as an accounting expert, rather than a FASB representative, contended that the purpose of financial reporting is to provide good information to financial statement users. “It is not there for regulatory capital or to boost the balance sheets of financial institutions,” he said. “This is not new . . . whether you call it fair value, or mark to market, or taking an impairment charge . . . the idea of marking things down in a down market has been the convention for a long, long time,” said Herz.

Sobre a Contabilidade e a Crise 8

outubro 3, 2008

Mark to market

Jennifer Hughes – 1 October 2008 – Financial Times – London Ed1 – 20

Facing a market meltdown, some regulators have pulled the plug on trading, as in Russia and Brazil. More have shut short sellers in their rooms. One of the few things not yet suspended is mark-to-market accounting. A temporary suspension is an attractive idea, on the face of it. Marking assets to market was always expected to lead to volatility: that was the price of transparency. But what happens when there is no market, or only an illiquid one?

For most of the past year, there have been few buyers for many bank assets. That has sent derivatives whose prices were based on them, such as credit default swaps, all over the place. The result has been “procyclicality”, as banks simultaneously recognised losses. This then triggered fire sales, which depressed asset prices further, and so on in a vicious spiral that can be as bad for stock markets as it is for banks. They did things differently in the old days – such as a few years ago. When banks held loans to maturity, regulators could turn a blind eye to technical insolvency and let banks recapitalise themselves slowly through earnings. That is what happened in the 1980s Latin American debt crisis and in 1990s Japan. Now, by contrast, a bank’s ability to operate depends on it being able to sell its assets overnight and have something left over for shareholders. If it cannot do that, it is bust.

To argue, however, that this system is responsible for today’s bank failures is absurd. The root problems lie elsewhere, in lax lending – although fair-value accounting has exacerbated problems. That is why central banks have pumped liquidity into markets, and allowed banks to exchange illiquid bonds for more liquid Treasuries. Instead, mark-to-market accounting is the price that banks must pay for a securitised credit system. Because it is volatile, those that use it need to be well-capitalised.

Sobre a Contabilidade e a Crise 7

outubro 3, 2008

Fighting fit for fair value fray

Jennifer Hughes – 1 October 2008 – Financial Times – London Ed1 – 22

Sir David Tweedie has been dubbed the “accounting ayatollah” by the French for his determined support of fair value rules. He has also framed a newspaper article calling him the “most hated accountant in Britain”.

Amid the current market crisis, the 64-year-old chairman of the International Accounting Standards Board faces increasing pressure to suspend the rules, which require companies to mark their financial assets at market prices. The 14-member board is holding an extraordinary meeting to discuss issues around the credit crunch tomorrow.

The Edinburgh University graduate began his career in academia lecturing on accounting but joined KPMG in 1982. As head of the firm’s technical team, he witnessed what he calls the “creeping crumple” of pressure on auditors to sign off complex financial products pushed by bankers.

He gained notoriety by fighting back as head of the UK Accounting Standards Board in the 1990s, also pushing for pensions accounting rules that disclosed yawning deficits in many schemes.

Sir David moved to lead London-based IASB in 2001 and has had to tone down his naturally straight-talking, argumentative side to get consensus among his board. But the grandfather of two seems ready for the impending battle over fair value rules.