The FASB’s amendment to mark-to-market accounting rules looks set to be approved today — giving US banks more flexibility to value their assets.
Time to buy banks then? Not quite.
While FAS 157-e, if approved, will allow banks to gauge whether prices for their assets were made during an inactive market and were therefore distressed transactions. If a market is found to be distressed, companies won’t have to use the depressed prices to value the assets on their books. Financial institutions can start using their own models to value their assets. It’s basically a license to increase the amount of Level 3 assets — those whose prices are based on ‘unobservable inputs’ — on banks’ balance sheets.
The bull case for banks then is this – FASB 157 has so far been too restrictive, forcing banks to value their assets at distressed levels and take subsequent (unecessary) writedowns. Revisions to mark-to-market rules will give financial institutions greater leeway to hold assets on their balance sheets at ‘more realistic prices’ — in other words they’ll be able to hold on until risk-taking returns and they can sell their assets for a ‘decent’ amount.
But there’s a hitch. Tim Backshall of Credit Derivatives Research put it well in a research note, via Reuters:
The hopes of the FASB mark-to-market snafu this week are in our view ‘crazy’ – we still know the ‘stuff’ is on the balance sheets and if the financials are actually allowed to adjust capital based on unreal marks then who will ever buy financials again – how can you trust them? … And what is the point of (the Public Private Investment Plan) if that is the case?”
That’s a very good point — there’s an inherent contradiction between FAS 157-e and the PPIP.
If the PPIP programme is all about price discovery — encouraging private buyers to snap up loans and other assets to create a market for troubled financial goods — then why suddenly amend the rules so that banks can avoid using those new market prices?
When Geithner first announced his plan, we wrote:
… what’s needed in the financial system is a bout of painful writedowns for banks and the acceptance of real prices for their assets. In that sense, Geithner’s plan may be a success by forcing banks to finally deal with their balance sheets in a realistic way. If the plan was however, intended as a not-so-subtle way of recapitalising banks at the taxpayers’ expense via overpaying for assets, we question whether it will work.
Combining the PPIP with FS 157-e, however, creates a whole new host of doubts. Firstly, will banks be willing to sell their assets at distressed prices knowing that they can keep them on their balance sheets at their own valuations? Secondly, if they do sell, they may still choose to value their remaining assets via their own models. That would result in a modest capital boost for the bank — but not much balance sheet cleansing, so to speak.
Back to the original question – is it time to buy banks? Well, no. For a start, most of banks’ financial assets and liabilities are in the form of loans, which are carried at historical cost and won’t be helped by FAS 157-e. Secondly, accounting rules may mask cashflow problems but they can’t hide them forever.
As the Aleph Blog puts it:
You can’t fight cash flows. Accounting exists to partition cash flows into periods, so that analysis of businesses can be done, and debt financing can be secured. In the end, cash flows win out, regardless of the accounting methods.Indeed.
Related links:
Don’t you know that you’re toxic – FT Alphaville
Geithner, the early maths – FT Alphaville
Letters to the FASB, or US citizens do accounting – FT Alphaville
Remarked to market, a bonus for US banks this week? – FT Alphaville
A first step towards mark-to-market suspension? – FT Alphaville
Ken Lewis: Mark to market not that big a deal – Clusterstock