More writedowns ahead for the big banks? A spate of negative analyst’s reports - led by none other than Oppenheimer’s Meredith Whitney - would have you believe so. But what about this:
Under SFAS 157, it is appropriate for you to consider actual market prices, or observable inputs, even when the market is less liquid than historical market volumes, unless those prices are the result of a forced liquidation or distress sale. Only when actual market prices, or relevant observable inputs, are not available is it appropriate for you to use unobservable inputs which reflect your assumptions of what market participants would use in pricing the asset or liability.
“This” is a letter sent by the SEC to Wall Street CFOs last week in anticipation of the next round of 10-Qs.
The distress sale caveat looks like an escape clause. Having required Wall Street to mark most of their structured finance models to model - as “level-3″ assets under SFAS 157 - the SEC is now inviting banks just to ignore their model when it suits them.
To wit: if asset prices fall too much, just ignore the price falls. In fact, create, buy or hold, whatever structured rubbish you like in the future because it doesn’t have to lose its value if you don’t want it to.
If the price isn’t right, just tweak and add “benefits” to your model to compensate for the effects of “distressed pricing”.
That is exactly what AIG did - and would have gotten away with doing, had it had a letter like this to wave.
Related links
Floyd Norris: If market prices are too low, ignore them - NYT
SEC gives permission to fudge mark-to-market - Naked Capitalism
