Toxic assets & increased transparency

Kenneth Scott and John Taylor argue in the WSJ that mandated disclosure is needed to help address the (still ongoing) issue of getting so-called "toxic assets" off bank balance sheets.

It's a(nother) good little summary of (part of) the problem, and how regulation is attempting to address the issue.

The old wall street is dead

Andy Kessler in the Weekly Standard has a go at explaining the recent meltdown.

Mark to market accounting- a 'clarification' from the SEC

The SEC and FASB have made a recent announcement on mark to market accounting.

"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."

Though that's what managers can do already. SFAS 157 allows 'mark to model' accounting. Prof Bainbridge has already made this observation.

Can we blame the accountings?

In relation to the current subprime/Wall st mess:

According to Anthony Randazzo at Reason (amongst many others)

Third, the SEC should suspend the "mark-to-market" accounting rules for long-term assets that are driving firms into bankruptcy. Essentially, these regulatory rules are forcing firms to value their assets at much lower prices than what they would be worth long-term. The intent of mark-to-market regulation was to keep firms from overvaluing themselves and deceiving investors. Instead the law has artificially devalued financial institutions as a whole, which hurts their investors. As Steve Forbes noted recently, "The mark-to-market mania of regulators and accountants is utterly destructive. It is like fighting a fire with gasoline."

Not so, say the ISAB (surprisingly :) [Note: pdf link]

The sub-prime mess still has an impact

Today, the National Australia Bank announced an increase in its provisioning by $830 million for exposure to CDO (collateralised debt obligations) which house some of its exposure to the US sub-prime market. NAB's share price dropped by over 10% on the announcement. The disclosure related question, of course, is when did they know about this?

Sub-prime stupidity

Dennis Berman in the Wall Street Journal calls it like it is.

The subprime realm has thus become a vital portal onto Wall Street, helping us understand just how upside-down the place has become. In this world, risk management is applied retroactively. CEO succession planning is, too.

Don't let those on Wall Street fool you by saying "this is the natural cycle of things." Does it really have to be? Unlike virtually any other industry, Wall Street shakes, twists, and hammers on its innovations until they break. What would happen if Boeing Co. or Johnson & Johnson rolled out products with similar defect rates?

Credit rating agencies / subprime / Citigroup

Still more on credit ratings. Turns out the mathematical models used by banks such as Citigroup to value securities like the securitized (sic) subprime mortgages (CDOs, or collateralised debt obligations) relies heavily on credit ratings. That led to the situation where (as we've discussed in class) a downgrade by a ratings agency becomes somewhat self-fulfilling. Wall Street Journal "Heard on the Street" article (via the Oz) here . [Note: this is one of the early benefits of News Corp buying Dow Jones. The Australian gets access to the Wall Street Journal. Goodbye AFR?

Credit crunch losses

Looks like the losses on the recent 'credit crunch' have topped US$18 billion, according to a report in the Financial Times section of The Australian (link). Most of the major banks in the U.S. are reporting write-downs in the value of their loans. It will be interesting to have a look at the reports of these companies to see how they have gone about the valuation of their loans.

I wonder if things would have been different if the U.S banks had to file half-yearly (as in Australia) rather than quarterly. In particular, I wonder if the banks would have disclosed to the ASX the extent of their write-downs under the Continuous Disclosure obligations.

A sub-prime primer

If you were wondering what all this 'sub-prime' stuff was about, here's a useful little article from the Sunday Telegraph (the U.K one, not the Australian one).

Accounting for sub-prime losses

The banks (especially in the U.S.) will be preparing their quarterly accounts at the end of September. One of the big issues they will be facing is how to treat their exposure to the sub-prime mortgages. Their assets should be 'marked to market', i.e., banks should determine the 'fair value' of the mortgages (and securitised tranches of mortgages etc). While there are rules as to what to do (i.e. fair value accounting), there is less guidance as to how to do it (i.e. value the mortgages). One of the issues with fair value accounting is the appropriate treatment when there is no active and liquid market (from an Oz article found here:

The banks are also facing losses on their holdings of complex securities where there is often no clear market price because of low trading volumes.

This highlights one of the key issues facing accountants in the future; are they going to take up the role of valuation experts, or will they subcontract out of that role and focus more on the straight 'bookkeeping'. With the move towards fair value accounting standards globally, there will be a dramatic increase in work for valuation experts.

Credit ratings - worth the paper?

Are the credit rating agencies doing their job well? Stephen Ellis, in discussing the 'sub-prime' mortgage market in The Australian, thinks not. Key quote:

And although S&P and Moody's seem to have been the victims of at least some fraudulent misrepresentation of mortgage quality by originating lenders, it seems fair to ask why they were not checking this information in the first place, given sub-prime mortgages were a startling 20 per cent of the entire US home mortgage market last year.