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Banks May Be the Only Winner In New Rules for
Toxic Debt

Topics:Recession | Consumers | Retail Sales | Mortgages | Interest Rates | Housing | Real Estate | Federal Reserve | Politics &
Government

Sectors:Retail | Banks

By: Albert Bozzo, Senior
Features Editor | 03 Apr 2009 | 02:48 PM ET

Text Size

There’s little dispute that the
government-sanctioned move to allow accounting flexibility in valuing toxic
assets will be good for the banking industry. The big question is whether it's
good for anyone else—including the federal government.

CNBC.com

Capital Money

In voting to let banks exercise
more judgment in using the so-called mark-to-market accounting rule, the
Financial Accounting Standards Board is also thought to be trying to revive the
market for such troubled debt-based assets so banks can remove them from their
books, rebuild capital ratio levels and undertake new lending.

How The Toxic
Assets Program Works

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Sounds good. But the change may be
solving one problem while creating others, say market and accounting
professionals, as well as former regulators and government officials.

“The banks won't sell as long as
they can keep the assets on their balance sheet at unrealistically high values,”
says Robert Glauber, who supervised the first Bush administration’s handling of
the S&L bailout and now serves as a trustee of the International Accounting
Standards Committee Foundation.

The FASB ruling on fair-value
accounting—which many call confusing and poorly articulated—essentially allows
banks to value what have become hard-to-price assets based on their cash-flow
value—not their so-called market value, which in most cases is non-existent, or
illiquid. The same thinking would apply to losses or gains on positions, which
directly affects earnings.

Until the accounting board move,
pricing or re-pricing the assets—a key step in recreating a liquid marketplace,
analysts say—was thought to be extremely difficult.

For that reason and others, the
Obama administration felt it necessary to intervene in the marketplace by
conceiving a government-subsidized bidding system, known as the Public-Private
Investment Program or PPIP, that would connect banks looking to sell assets with
private investors such as hedge funds and private equity firms interested in
buying them.

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With Bailouts

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on Economy

Some say the mark-to-market change
will undercut the attraction and effectiveness of that bidding program, despite
its generous government guarantees.

“The banks are going to say why do
I need to deal with the PPIP,” says Lawrence White, a former White House
economist and savings-and-loan industry regulator. At the least, it “raises the
price at which they would be willing to sell to a PPIP entity.”

Glauber, who was recently named
interim non-executive chairman of Freddie Mac, says the
toxic asset program, which was problematic in the first place, has been
weakened. “The best way to get price discovery is to get transactions," he says.

Veteran money manager Jim Awad,
managing director at Zephyr Management, says the government’s  PPIP is
likely to become less attractive to potential buyers, as well.

Hedge fund and private equity
firms have been trying to buy troubled assets for months at distressed prices,
but have been turned away by sellers.

“If they can't get these things at
the right price, then why bother?” says Awad.

The right price, of course,
depends on who's applying the new equation.

The value of mortgage-backed
securities any given time, for instance,  depends a lot on default rates,
say analysts, which is a key factor in determining cash flow, as well as losses
or gains on positions going forward.

“To me that's what it is all
about,” says White. “Banks have always had a more optimistic view of what the
default rates would be than the outside market.”

RELATED
LINKS

Current DateTime: 12:27:32 15 May
2009
LinksList Documentid: 30031116

Mark-to-Market Relaxed

Banks May Buy Toxic Debt

'Double-Edged Sword' for Banks

US Unveils Complex Plan To Deal With
Toxic Assets

Obama's Toxic-Asset Plan: End-Run
Around Congress?

The more optimistic the scenario,
the higher the value.

“Why wouldn't you if you were a
banker?” says Awad. “As long as you can justify it on the models.”

Model is an interesting choice of
words, because skeptics of the accounting rule change say it essentially creates
a hybrid between mark-to-market and mark-to-model principle, the latter of which
uses internal assumptions, variables and timeframes on assets that don’t have a
regular market.

“It really will permit people to
mark to model,” says former SEC Chairman Harvey Pitt. “The thing that’s been
creating the problem has been the lack of a coherent methodology that everyone
follows so there is comparability across financial statements.”

Pitt and others say the change
essentially replaces one artificial approach with another.

“Its not an accounting issue,”
says Pitt, who opposes outright suspension of mark to market. “It’s an economic
issue. Do we really want the accountants making national economic
policy?"

“It’s almost a wink and a nod to price discovery," says Rep.
Michele Bachmann (R-Minn.), one of the more ardent proponents in Congress, where
there was unusually high bipartisan support. “We all realize this is fake price
discovery but it will lead to real price discovery.”

Supporters of the accounting
change say potential buyers also needed something of a reality and that's been
accomplished.

“The expectation of a fire sale
was ridiculous,” says Scott Talbott, SVP of government affairs at the Financial
Services Roundtable, a major industry trade group. Talbott  says the new
valuation approach “helps price discovery” and should narrow the spread between
bidder and sellers with or without the government's participation.

Successful or not, the
mark-to-market change may at least make the PPIP “politically palatable,” says
Joshua Ronen, an accounting expert at NYU’s Stern School of Business. “It gives
political cover to [Treasury Secretary Timothy] Geithner "because the government
and its partners “won't have to offer prices significantly above what’s on the
books.”

Some in Congress say the
accounting change may even wind up making the government’s toxic assets purchase
program unnecessary.

“I would hope that it would.
Ultimately the price discovery has to come from willing buyers and sellers,”
says Rep. Bachmann, who adds she’s “not a fan” of the Treasury's plan. “Some of
the [financial] commitments we’ve made, we may not see them realized.”

© 2009 CNBC.com

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