Accounting »

Yesterday, FASB, the Financial Accounting Standards Board, issued new U.S. accounting standards that give the financial gamers the fudge factor they wanted; this ruling gives banks and financial institutions the ‘flexibility’ to make it appear that they are more solvent than they really are.  We’re going with the babymind, “You can’t see me because I have my eyes covered!” instead of the grownup mind that tells us that honesty and integrity are the best long term policies.  How frustrating.

Our financial system allows banks and investment houses to leverage very small amounts of capital into enormous empires of fee extraction tools.  Current rules about keeping enough capital reserves on hand to cover commitments have evidently been naive and imprudent; too many players skated or skirted the rules instead of acting responsibly.  Institutions with prudent reserves have weathered this downturn.

Now, instead of strengthening the requirements for reserves and insuring that all our institutions are sound, this FASB ruling allows financial institutions to fudge the value of the assets they have on their books, so that they do not need to raise more capital reserves.  This is a democracy, so we are all responsible for our government’s actions:  our accounting rules yesterday moved toward easier gaming, instead of toward a more responsible securities trade.  Speak up if you are in favor of truth-telling instead of sugar-coating.

Keeping up appearances
This rule says, if you can make your books look good, then that’s OK by us, because then you can get back in the game more easily, whether or not you are a responsible player.

It is the equivalent of allowing you to keep your house on your balance sheet at a good, imaginary, future selling price when you go into the bank for a mortgage, and then allowing you to borrow 99% of that value.  You would be able to go out and spend more, too, if banks went along with this game.  You might even be able to take the money that they lent you and invest/leverage it into a nice fat profit.  WE’re being asked to lend banks money on their inflated, imaginary, future valuations of the assets on their books, so that they can lend, invest, leverage and make a profit.  AND, we’re being asked to guarantee any risks they might encounter should these totally subjective, balance-sheet fudging valuations get them into deeper hot water than they are in now.

This is the same choice that the Catholic Church made when they chose to ignore predatory priests to maintain good appearances.  It reflects a belief that looking good helps people keep the faith; the truth would hurt.  It reflects a childlike belief that what we do not know cannot hurt us.

The FASB rule relaxing is rationalized because we have a financial system that is faith-based and that requires the CONfidence of participants to keep the growth pyramid expanding, so that the big players can keep making profits.  “Too much truth is bad for business when business is all about the confidence con.”

Fudging over fact
Allowing banks to subjectively mark the value of some of their assets will allow them to resume gaming the system, without taking the steps required to make them truly solvent, responsible players. This perpetuates the system that got us into trouble; the system collapsed because it was a giant pyramid of imaginary valuations.  The credit freeze is not so much a liquidity problem as a systemic problem of insolvency.  This accounting rule fails to recognize the systemic issues and hauls out the helium to reinflate the balloons.  It won’t work any better for our financial system, than choosing present appearance over truth did for the Catholic Church.  A day of reckoning can be postponed, but not eliminated.

Valuation is complex only when you’re doing your best to BS
Financial instruments may be more complex and harder to value than ever, but that does not mean that they actually have more value than the current market value, nor that they actually make a contribution to global productivity.

Prior to the 1980s, “financial instruments” were relatively simple, and relatively simple to value.  For example, a mortgage value is easy to assess.  Prior to 1990, banks were careful to get plenty of information about borrowers, and the chance of default could be accurately assessed based on historical data.  This was generally true for all financial instruments.

Beginning in the 1980s the financial markets introduced ways to insure against risk, which morphed at warp speed, beginning in the late 1990s, into giant games, where financial players could extract enormous sums of money by betting on bets that bet on other bettors.  The bets grew to a $67 Trillion market, and the face value of the instruments upon which they were betting mushroomed to about $600 Trillion.  The entire global GDP is only about $65 Trillion, so the size of the speculation is truly jaw dropping.

When you figure that the gamers were personally extracting from 2-30% of that $67 Trillion in bets, you get some idea of the resources they have available to bend Congress and the Administration in directions that will allow them to get the game going again.  When people tell you that these derivatives are just so complex, they require a lot of ‘flexibility’ in choosing a book value, wake up your inner adult right now!  You’re being gamed!  This is OUR financial system.  Demand prudent, responsible actions.

Sift through the jargon, and the golly-gee this is just so complex, we need ‘flexible’ rules to bend around all these complexities, and the relaxation of the mark-to-market rule is simply another bend over before the con men.

Honesty is the best policy
Sophisticated investors in banks and securities firms want to know the good, the bad and the ugly.  When you tell people the truth, they will take calculated risks, and are less likely to take euphoric, manic action; the system is stronger.

Dump the Mark-to-Market advocates: Steve Forbes, Newt Gingrich , Information and Analysis: Wikipedia,  Motley Fool, BaseLineScenario.