On Thursday April the 2nd the FASB (The Financial Accounting Standards Board) changed the Mark-to-Market accounting rules to Mark-to-Model FAS 115-2 and FAS 124-2.
What is FAS 115-2 ?
FAS 115-2 says that defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements, the Board having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this Statement does not require any new fair value measurements. However, for some entities, the application of this Statement will change current practice. to determine whether the holder of an investment in a debt or equity security for which changes in fair value are not regularly recognized in earnings should recognize a loss in earnings when the investment is impaired. An investment is impaired if the fair value of the investment is less than its amortized cost basis (*1) .
If I want to translate it in plain English, FAS 115-2 says that financial institutions do not need to report their toxic assets losses in quarterly earning unless the credit portion of OTTI(Other-Than-Temporary Impairment)(*2).
Yes you heard it right!
Here is my thought on this subject.
You might know the definition of Mark-to-market accounting, but just in case, I write it for you. Mark-to-market accounting is an accounting methodology of assigning a value to a position held in a financial instrument based on the current market price.
You might think it was a good change that caused the 3% rally yesterday,but Here is the problem:
This change in the accounting law will help banks to hide their losses. There will not be any clarity in the banks earning any more. Banks can value their asset base on fair-value accounting standard, it means they can price them anything they like. It means, they no longer obligate to value these toxic assets to the real market value. Therefore quarter earning will be inflated and unrealistic.This change causes banks not to raise the necessary capital and keeps Zombie banks alive for a longer period. I need to remind my readers that Bear Stearns collapsed because they valued their assets base on Mark-to-model; therefore they did not feel the need to raise capital!
Government knows banks can not raise any capital from private sector therefore they are hoping by hiding their losses from investors keep them alive for a longer time. They hope by hiding the losses, stock market will rise and higher stock value helps banks to raise capital again!
The current rally was due to speculation of P-PIP (Public-Private Investment Program). Speculators hoped it helps banks to get rid of their toxic assets .
Here is the problem, if banks allow to value their assets anything that they want, why should they sell it? How could you convince the private sector to risk its money to buy them!!!
These idiots in congress just postpone the problem. If there is a dead body in your house, by hiding it in the closet your problem will not go away. We have to brake these Zombie banks to smaller entities or put them into a conservanship. This change will cause the P-PIP become a failure and this rally will be the biggest bull-trap ever.
In the end to avoid any confusion, I recommend FASB changes the Mark-to-market accounting rules to "Mark-to-Fantasy" (;
(*2)Definition OTTI: Other-Than-Temporary Impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The guidance in this FSP is applicable for investments in:
Debt and equity securities that are within the scope of FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities
Debt and equity securities that are within the scope of FASB Statement No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations, and that are held by an investor that reports a “performance indicator” as defined in the AICPA Accounting and Audit Guide, Health Care Organizations
Equity securities accounted for at cost (thus, they are not subject to Statement Nos. 115 and 124 nor to APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock).
FAS 157: It defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements, the Board having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute.