Tuesday, March 17, 2009

"Mark-to-Market" vs. Solvency Buffers

Long, not terribly technical article here.

The gist?

Accrual accounting provides a balance sheet solvency buffer; Fair Value accounting takes the buffer away and can lead to increased volatility in earnings and capital.

(Fair Value is the functional equivalent of "Mark to Market.")

When FVA/Mark-to-Market was introduced, the 'slop bucket' was evaluated based on "fire sale" pricing. In truth, that's not the best way to value any asset, unless you ARE having a "fire sale." (See Circuit City, e.g.)

The effect? Big hits to reserves and capital, leading to a lot of meltdowns.

Yes, a lot of bankers woulda/coulda/shoulda taken writedowns on their toxic assets, perhaps more quickly than they were doing under the old protocols.

But now we are all living under "mark-to-market" pricing--at least indirectly. That old car you have in the driveway--is it worth $2,500.00? $1,500.00? Or $100.00? Same with that old vertical-mill in the shop.

Maybe YOU don't care--but your banker does, these days.

3 comments:

Shoebox said...

Yes they do but here's the difference...as long as you keep making your payments the bank doesn't care that your car is worth $2,000 less than the loan. In fact, most car loans are upsidedown for the early stages of thier life. If rather than M to M they were looking at some version of discounted cash flow, assuming they are not having to sell the asset, this would be more accurate to the assets actual value. it looks like this is going to be corrected...an about time. I think the plan will have F/S still reported with M to M but for capital calculations they will have a cash flow analysis and then disclose the difference. This approach should satisfy both sides of the issue.

Dad29 said...

But it DOES make a difference in your balance sheet. IOW, for non-amort lending, asset-values actually have impact.

You're right--it appears to be a "bi-lateral" resolution.

Shoebox said...

Absolutely. The issue is what is "fair value". Unfortunately, with the litigousness that exists and the murky guidance from FASB and the SEC, coupled with our favorite Sarbanes/Oxley, folks are pushed into the most conservative postion. Like every other word from "The Won", all these folks are now saying "this is not what was intended!" Doesn't matter, it is the logical outcome of what you have regulated. If you want a different outcome, you need to change the input or the process.