Will Banks Start to Walk Their Talk? Don’t Hold Your Breath (Mark to Market Edition)

The new meme from big embattled banks, starting with Citigroup’s leaked Pandit memo yesterday and Bank of America CEO Ken Lewis’ declaration that the bank will be profitable in 2009, is that things will be OK and all this talk of nationalization is unwarranted.

I’ll reserve judgement till the fat lady sings. The record of financial crises suggests the housing market has lower to go (which is consistent with the notion that prices need to revert to historical norms relative to incomes and rents) and that unemployment is far from its peak (the Reinhart/Rogoff historical comparisions suggest US unemployment will reach 12%).

The flip side is the point made by John Hempton: US banks earn fat spreads, so their earnings power is good (for those who read his detailed post, note some have raised objections to some of his assumptions). That has been enhanced by the Fed’s near zero Fed Funds rate. And as we have noted, the fat interest spreads that are good for banks are not so good for borrowers. Yes, some have raised concerns about the requirement that banks participate in various “get the housing market going” programs may work to their detriment, but frankly, we are skeptical that these programs will come close to reaching the number of homeowners Team Obama bandied about.

So the 2009 picture boils down to how much the big banks have in the way of writeoffs, AND let us not forget, how well they do in their trading operations. Ken Lewis seems to still be depicting BofA as a conventional bank, and ignoring that Merrill could deliver losses and further writedowns.

Ah, but relief is coming on that front too. I must confess that I did not watch the Senate hearings, but mark to market looks to be dead. From Bloomberg “Lawmakers Tell FASB to Change Fair-Value ‘Quickly’ “:

U.S. Representative Paul Kanjorski said regulators must act “quickly” to give companies more leeway in applying the fair-value accounting rule that banks blame for exacerbating the financial crisis.

“If the regulators and standard setters do not act now to improve the standards, then the Congress will have no other option than to act itself,” Kanjorski, the Pennsylvania Democrat who leads a House Financial Services capital markets subcommittee, said at a hearing today. Fair-value, which requires companies to mark assets to reflect market prices, has “produced numerous unintended consequences,” he said….

Kanjorski said he isn’t advocating suspending the rule, because such a move would bring back “the very kind of subjectivity and sleight of hand that made mark-to-market necessary in the first place.”

Eliminating fair-value “would diminish the quality and transparency of reporting, and could adversely affect investors’ confidence in the markets,” Herz said. The rule “can help to more promptly reveal underlying problems at financial institutions.”

Guidance being prepared by Norwalk, Connecticut-based FASB will encourage companies and auditors to use their own judgments in valuing assets, Herz said.

You cannot have it both ways. The Senate is trying to pretend it is going to keep fair value accounting in a somehow friendlier form, but friendlier to the industry means the financial statements are no longer reliable. They cannot be trusted. Anyone who thinks so needs to recall the example I keep harping on, Lehman. Even with mark to market accounting, Lehman delivered $100 billion in losses to unsecured creditors on a $600 billion and change balance sheet. That level of misvaluation should be impossible (absent exempted categories like Level 3 assets, which are openly phony baloney). If this wasn’t accounting fraud (and I am inclined to believe it was) then the existing rules were so loose you could steer a supertanker through them. Lehman says there is ALREADY too much play in the existing rules, not too little.

You cannot be half pregnant here. Either you have objective standards or you don’t. The notion that subjective valuations will be permitted and they won’t be abused is utter fantasy.

The reason fair value was implemented, was, to paraphrase Churchill, it is the worst way to value financial assets except all the others that have been tried. Historical cost is misleading in an environment where interest rates can move significantly over the life of the asset. Banks also tended to avoid writing down or reserving against assets until they were clearly impaired. Hold to maturity (which is what is used for loans, and presumably some variant will be the new fair value compromise) has considerable subjectivity.

One bad feature of mark to market is that it it pro-cyclical. That is, as market values in general go up, the value of assets on financial firm balance sheets go up. Say assets formerly valued at 100 are now worth 120. Oh, and guess what? That gain in value increases your equity by 20. If you are a Wall Street firm, you’ll pay some to yourself, but you’ll lever up the portion you retain. So firms take on more risk even thought their holdings have not changed, merely their valuation. No one had any problems with mark to market when it was making everyone look good. The process operates in reverse on the way down (except those employees still keep paying themselves, funny how that works).
Of course, there is another solution, which is to have procyclical capital requirements (higher when prevailing asset prices rise, lower when they fall) and some have been worked out in considerable detail. But that is far too sensible and offers no quick relief to banks desperate to slather lipstick on the pig of their balance sheets.

Some have contended that the death of mark to market is no biggie, such as David Reilly of Bloomberg, who argues that, based on his analysis, it applies only 29% of assets the 12 biggest banks in the KBW Bank index.

First, if you look at the index, it excludes Goldman and Morgan Stanley. Second, Merrill was purchased by BofA AFTER its latest report date, so its inclusion might boost the total a tad. Looking at mark to market and reaching conclusions based on figures that exclude many of the systemically important global trading firms is silly.

Second, 29% is still vastly in excess of their equity. If the elimination of mark to market allows banks to make their valuations of these assets more flattering by, say, 10%, that would exaggerate their assets by roughly 3%, which goes straight to their net worth. For instance, on a quick and dirty pass, Citi’s balance sheet (conveniently excluding its roughly $1 trillion in SIVs) is $1.9 trillion and shareholders’ equity is $142 billion, or 7.3%. An additional 3% would be an over 41% increase.

So yes, the banks may look just ducky soon. They are going to continue to get plenty of subsidies from the authorities, via super low interest rates. the fancy new facilities that will boost their profits, such as the new $1 trillion asset backed facility (I think TABSF, but I can no longer keep them all straight, which is no doubt part of the point).

In the meantime, the taxpayer will continue to subsidize banks, the banks will get to keep the upside, and (as in credit cards) charge fat spreads. Ain’t capitalism wonderful?

If the banks were really doing as well as their PR suggests, they would not need to use the to be launched public private garbage barge operation. Do you think there is a snowball’s chance in hell of that happening?

We are going straight down the Japan path: propping up banks rather than forcing them to recognize losses, and providing the same sort of accommodative accounting to boot. All it did for them was kick the can down the road a few years, at considerable cost to its society. But that’s what you get when the executive and regulators are unwilling to challenge the primacy of the banking class.

Update 3/13. 12:30 AM: You gotta love Floyd Norris:

If mark-to-market accounting is to blame for the current financial crisis, then the National Weather Service is to blame for Hurricane Katrina; if it hadn’t told us the hurricane hit New Orleans, the city would never have flooded….

Sadly, a victory for the bankers would not help them much. Even if it were true that banks would be held in higher regard now if they had not been forced to write down the value of their bad assets — and that is, at best, debatable — changing the rules now would be counterproductive. Would you trust banks more? Would other banks be more inclined to trust banks?…

Although you would not know it from the angry complaints, the accounting board’s Statement 157 did not require mark-to-market accounting. That was already required under earlier rules. What it did do was clarify how such values should be determined. That stopped banks from defining “market value” as meaning whatever they chose it to mean.

Conrad Hewitt, who was chief accountant at the Securities and Exchange Commission when it conducted a Congressionally mandated review of the issue late last year, said at a recent Pace University accounting forum that he asked all the complainers if they had a better way to determine market value than the one prescribed by Statement 157. None did

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  1. Anonymous

    “No one had any problems with mark to market when it was making everyone look good.”

    Exactly, but frankly I think you have something more serious than that, and even Japan. This whole thing increasingly shows a system that will not allow itself to correct, it smells like the 1970s Soviet Union, where the elite do everything they can to paper over a reality that doesn’t match their books.

  2. Jim in MN

    Bravo! Two thumbs up!

    A lost decade is now the de facto policy strategy, and we should be so lucky. A Lost Generation is now the most likely scenario, with a mere Lost Decade as an optimistic outcome. The pessimistic outcome? Ugh.

    But we really need some sucker rallies to keep repositioning, so bring on the S&P's 200 day EMA…now the lid on the iron pot.

    –Jim in MN

  3. Stephen Lins

    Nice analysis. As I was reading it, I kept thinking “We’re going Japan” and in the final paragraph you hit the nail squarely. And this after all the years of our smug preaching to the Japanese about not facing up to their banks’ bad debt.

  4. Anonymous

    Another example mark-to-make-believe doesn’t work is GE capital. only 2% of their assets are marked to market, with the others marked at book subject to impairment test. Apparently, investors didn’t believe GE’s marks, priced the CDS and stock as if it is a junk credit instead of AAA.

  5. Anonymous

    How come no one screams that net income before provisions/write offs isn’t real net income?

    Ugh.. its like the neighbor bragging about his rental income on his small rental home empire. The only problem is he levered his homes at 100%, but they are now worth 60% of the original value. This whole issue is a balance sheet issue, not a net income issue!

  6. Anonymous

    I can’t believe that America can go down the Japan road. Americans in general do not have the patience for it…..which may be telling about the coming conflicts.

    The spin machine is whirling mightily these days in preparation for the G20.
    Got to make the financial system look stable, check.
    Got to make the market seem to be improving, check.
    Obfuscate, obfuscate and more spin….may we be hoisted on our own petard.

    The elite of the banking class have failed to be ethical at a minimum and probably outright criminal in their behavior. If they are not prosecuted for these transgressions there will be consequences as the hypocrisy of not doing so reverberates throughout the social fabric.

  7. Steve

    If the U.S. goes its own way on mark to market, corporate spreads will widen, more secondary markets will freeze as trading prices diverge further from carrying prices, and foreign capital will run even faster. But hey, if stocks rally for a little while, why not?

  8. Andrew Bissell

    We are going straight down the Japan path: propping up banks rather than forcing them to recognize losses, and providing the same sort of accommodative accounting to boot. All it did for them was kick the can down the road a few years, at considerable cost to its society. But that’s what you get when the executive and regulators are unwilling to challenge the primacy of the banking class.

    Actually, it’s what you get when you decide to provide government guarantees and backstops of bank liquidity and make “too big to fail” an explicit doctrine, as we basically have since the 1930s (and with particular ferocity since the early 1980s, when the credit inflation cycle reversed).

    The banking class acquired its primacy in the first place because of this policy.

    It’s like Jim Grant says: bring back the bank run. Prudent depositors are capable of fending for themselves, and they need to start, because the FDIC certainly isn’t fending for them.

  9. alex black

    Whatever T-shirt factory Obama used for all those “Change We Can Believe In” T-shirts is now gearing up to print ones that say “What’s good for CITI is good for America!”

    Damn, these guys are good. “Zombie bank” was becoming a popular buzzword; people were catching on and resisting, so the banks and there reps in gov’t needed to change the meme. The new one is “All the banks are healthy” They’ll decline that $5 billion bailout coming to their front door, and Obama will give a great speech declaring how he’s saving the world, to distract people from the $100 billion in taxpayer money going through the banks’ BACK doors. Anyone who dares to point to the back door swindle will be shunned as a buzzkill, a thief of Hope.

    For all of you writing in from your personal computers, it will be nice to finally meet you all at The Hope and Change Re-education Camp.

  10. john bougearel

    This implies the gubmint is going to help make Lewis and Pandit look like 2009 “prophets of profits.” The lawmakers will have to color them fictitious, it is all so disgusting. Legalizing fraud is what they will be doing, in a nutshell.

  11. lineup32

    The FED Flow of Funds out today and homeowner equity is down to 43% lowest in 52 years. Commercial to follow along the same path so basically real estate has little or no collateral value for the banking industry, so banks will make up numbers.

  12. alex black

    Yes, banks will make up numbers, but as long as they can get enough taxpayer money shoveled into them through one scheme or another, soon enough those numbers will be true!

    They’ve got the bagmen, the bagmen have the money; they just need a leeeeetle more time…….

  13. Anonymous

    Kick ass post!

    Japan, since the end of W.W.II, has always been a ruling elite research and development program for the off shoring of manufacturing, social engineering and financial manipulation. It fits the global ruler and ruled scenario that we are rapidly being pushed into.

    Keep kicking, united we will all push back.

    Deception is the strongest political force on the planet.

    i on the ball patriot

  14. Tom Stone

    When you have a system that in the last analysis depends upon trust,and you destroy that trust,there are consequences…

  15. Anonymous

    Its getting old. They will deflate their way out altogether with foreign partners. Like Keynesians should do. Bye-bye bears.

  16. Anonymous


    So the capitalistic markets are akin to the Holo Deck on the good ship Enterprise, where parameters can be changed for_eye candy effect_regardless of their ever increasing removal from reality or the laws of the Universe.

    Day to day (Q to Q) survival is the name of the beast, with little regard to the long term prospect of the American people or its counter-party’s. We do owe a great deal of the burden for this event and should in a proverbial act of good faith, pull our collective heads out of the bulbous American anatomy manufacture by our overcompensating exceptionalisam and take a good hard look at our selves.

    If we wish for the_Rule of Law_ to return and hold those at the helm responsible, lets start with our selves, with out childish excuses like every one else was doing it, but I did not know the repercussions of my actions (others would be hurt or diminished).

    It is time, to “MAN UP” (aussie vernacular) and take our medicine, prepare for the pain and move on. Yes forces beyond most peoples comprehension have been applied to the collective masses from a drip to a flood of manipulation, but its high time for us to regain control of our fate and not take the low road of disassociation and wash our collective hands like we have no say in these matters.

    We must accept responsibility for our actions in empowering the very people or organizations, that to day we wish to hold accountable, we gave them social license, but that can be revoked by the tearing up of the social contract/license.

    Its your choice, to go down like a lamb or at least have tried and to make your voice heard, call your local news paper, congressman, senator, MSM outlet and most of all inform your self and others. Don’t leave it all up to Yves, and her contemporary’s, to do all the leg work for you. I would not tell you how to think, but to gain an informed position and speak with a loud voice or be prepared for the roll over.

    It will be hard, many will suffer and the road will be long, what will carry us forward will be tenacity, the never ending belief in that which is good and whole in our selves, and that policy regurgitation by self interest groups for their personal profit/benefit is the bane of us all. We have been slapped by the glove of challenge, how will you be when the tally is put to account, a conscript, turncoat, fair weather friend or self involved personality. Its time to relearn the American Identity or to put your mouth and ass on the line for the_greater good of us all_and not just for wealth creation, but for the continuance of OUR republic.

    Skippy….channeling Doc Holiday…rest up mate we need you.

    P.S. a patriot does not ware a pin on their uniform or espouse their position with self enrichment as a outcome, in fact a patriot will reduce himself and his seed for the greater good of the republic, with out glorification for all to see, and to risk historical nihilism. The easy road leads to reduction or worse extinction, where the hard road leads to continuance/adaptation.

  17. bondinvestor

    anonymous 10:19, my understanding is is that cohen pulled out because he realizes geithner is failing miserably.

    the idea that rodgin cohen – the greatest banking lawyer of past 50 years – would work for tim geithner was always a bit strange. i figured cohen’s name was leaked by geithner in an attempt to create the appearance that talented people wanted to come work for treasury.

    from what i hear, the top job is rodge’s for the taking. they just have to figure out a way for timmy to save face.

  18. Swedish Lex

    On mark to market.
    The EU is actively re-considering changes to deal with procyclicality in addition to the changes that came last year.

    Expect U.S. Congress, issuers, etc. to be watching EU / IASB developments very closely. A good reality test will be to see how far the Europeans go, assuming they go first.

  19. Anonymous

    “We are going straight down the Japan path: propping up banks rather than forcing them to recognize losses, and providing the same sort of accommodative accounting to boot. All it did for them was kick the can down the road a few years, at considerable cost to its society. But that’s what you get when the executive and regulators are unwilling to challenge the primacy of the banking class.”

    The filth that governs us can face nothing, all the showboating it does and the lip service it gives to those that supported it in the naive hope that principle would have pride of place in the years just ahead nothwithstanding. We have an anti-war claimant that “surges” in other countries, a despiser of earmarks that embraces them, and the author of a “new direction” in foreign affairs that says nothing while the thugs at AIPAC smear his appointee to head NIC. Barak Obama is a weasel, an eel that would never permit the American people to get in the way of those who so handsomely financed his election campaign. For them and the Likudists that have our democracy by the throat, he’s, sho nuf, just Mr. Bojangles.

    Maybe after a decade of the kind of malaise Japan experienced in the 1990s the American people will at last recognize that they’re in a war with those that claim to serve them and will muster the courage to launch the demonstations and strikes necessary to bring these vermin to the defense table at some enormous show trial. As presently constituted, our political system is no longer capable of a response to clear expressions of the public will. It is simply there to serve the personal interests of those that manage it. Its time for a whole new approach, and a new constitution.

  20. Anonymous

    Damm you doc holiday,

    How many Americans are ready to die or be reduced for their LCD/Plasma TVs, SUVs/transport, for the right look from their social group, house’s for preconceived self elevation, did not our fore fathers try and create a system by which all party’s could co-exist in relative balance, now who screwed the pooch in this deal, the common man or the people in power for self gratification.

    JB, Richard, Vinny, Richard Smith, Doc, Rue, Anon and more names than I can recount, this is becoming a gutter fight, we will need to take off the kid gloves and start to talk in the common language. The convergence of multipliers is off the scale, to compensate sophomoric, warning, danger will Robinson danger, danger!

    Skippy…I’m tired to doc.

  21. Independent Accountant

    I love bank runs. Short of the hangman’s noose or the guillotine, they are the only way to discipline banks.
    I have a better idea for Congress. Instead of blaming the CPAs, repeal the laws against: wire, mail, bank and securities fraud. That’s the ticket.

  22. brushes9

    The GOP clowns in the media are pushing that Obama ALREADY IS challenging the “banking class:”

    From: http://www.slate.com/id/2213029/

    “War on the Rich”

    “On Tuesday, Washington Post columnist (and former Bush speechwriter) Michael Gerson argued in an op-ed that “Obama chose a time of recession to propose a massive increase in progressivity—a 10-year, trillion-dollar haul from the rich, already being punished by the stock market collapse and the housing market decline.” The plans are so radical, “there will not be enough wealthy people left to bleed.” CNBC’s Larry Kudlow wrote that “Obama is declaring war on investors, entrepreneurs, small businesses, large corporations, and private-equity and venture-capital funds.” Other segments on the financial news network warn of a tax on the rich, a war on the wealthy”

  23. Kady


    You’ve mentioned the Lehman balance sheet hole a few times in your blog. Have you ever done an entire post on this? I must have missed it. If not, would you? I’m quite interested in what exactly happened w/ the Lehman failure, both in terms of what the books of Lehman really looked like and how exactly the Lehman panic contagion spread.

  24. brushes9

    As Dean Baker points out, Pete Peterson fills peoples minds with junk facts and figures (IOUSA.) He has a budget of billions of dollars and is very successful. If junk goes into the American people’s minds, you can expect junk to come out?

    From: http://www.huffingtonpost.com/bill-scher/waking-up-the-fiscal-wake_b_174323.html

    “Social Security and Medicare opponent Pete Peterson funds through his foundation a “Fiscal Wake-Up Tour,” which characterizes itself as a non-ideological truth-telling presentation bravely warning the nation that Social Security and Medicare need drastic changes to save our children from crushing debt.

    But the “Fiscal Wake-Up Tour” actually is the worst kind of ideological exercise, one that blindly follows a political position regardless of the facts.”

  25. brushes9


    “Hickey pointed out that contrary to media claims and the alarmism of right-wing think tanks like the Peterson Foundation, Social Security is not in crisis and that the best way to reform Medicare spending is through reforming the whole health care system. These positions, Hickey added, were ones on which candidate Obama had campaigned.”

  26. Andrew Bissell


    I guess you could say Social Security and Medicare are well capitalized. Why, they’re loaded to the gills with U.S. Treasury securities! Best paper in the world! Still AAA rated! Backed by the unlimited, crushing taxing power of the United States government! Invest today!

  27. Diogenes

    There are bad reasons for abolishing MTM accounting (some of which you touch on) but there is also one very good reason.

    MTM is based on a misunderstanding of the Efficient Markets Hypothesis and is applied arbitrarily. Why is it more logical to use the market value of the assets side of the balance sheet to determine net worth than to use the value of the liabilities side of the balance sheet to determine the value of gross assets?

  28. Anonymous

    If GM declared bankrupt tomorrow then probably many of the US banks would not be making a profit this year. What they are saying is that they will make a profit this year providing they don’t have to make big write downs and interest rates stay at historic lows and the government continues all its bailout schemes. They are gambling that there will be no big credit event, credit card lending will not deteriorate, the housing market will stabilise, business defaults will not be higher than in recent recessions etc.

    Since the international accounting standards were only recently downgraded (January 1st 2009 update 1-IASB’s ) to match US mark to market rules which benefited a lot of European banks a further relaxation of the US rules will give investors a choice. Invest in banks under international rules or under US mark to myth rules. Not that it makes much difference as banks shovel everything into level 3 assets which I believe are not mark to market anyway. I guess they needed some way around those GE write downs now that it has been downgraded.

    The right thing to do is to reduce capital requirements during a downturn, that is what it is there for as a buffer to be used in a downturn. That’s the route the Europeans are looking to take.

  29. M.G.

    If people, and a large majority (read below), start to become optimist it will be a self-fulfilling profecy for the bankers which go to “business as usual” saying sorry “Egregi signori, abbiamo scherzato” or “Dear Sirs, we were only joking”. If you translate instead of joking screwing around I would say “Dear Sirs, we were only screwing around (not screwing up)


  30. s


  31. john bougearel

    Yves, Nice catch.

    I was still digesting BNs David Mildengberg’s March 11 piece about lawmakers considering restructuring the banks so that the bondholders share the pain and take a haircut to improve capital ratios. Guess all that won’t be necessary after all, because with a stroke of the pen, you can mark all these loans at “hold to maturity” levels. And voila, capital ratios improve even as those loan values continue to decline.

  32. tz

    But which market? If you had to sell your home, what could you get for it. If it had to be sold in 24 hours? 72? One month? Three months? A year?

    You would get many different (and generally increasing) results.

    If it is mark to true market (exchange traded or something openly bought and sold during a stable time), fine, but there seems to be a “mark to the last tick” which I don’t think is desirable.

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