Hidden Risk in Accounting Gimmicks

from Econompic blog:
Off balance sheet only frees up capital because it hides risks. This is absolutely mind boggling. Not the fact that they are asking, but how is this even a remote possibility?

FASB Relaxes Mark to Market Accounting

from Bloomberg:

The Financial Accounting Standards Board, pressured by U.S. lawmakers and financial companies, voted to relax fair-value rules that Citigroup Inc. and Wells Fargo & Co. say don’t work when markets are inactive. The changes to so-called mark-to-market accounting allow companies to use “significant” judgment when gauging the price of some investments on their books, including mortgage-backed securities. Analysts say the measure may reduce banks’ writedowns and boost their first-quarter net income by 20 percent or more.

Interestingly, the lack of transparency for these instruments was one of the primary factors that created the crisis in the first place. The mark-to-market rules were instituted to correct this error. This appears to be calibrated more to reinflate the bubble -- not to correct it.

Mark to Market Suspended by FASB

from John Mauldin:
The US Financial Accounting Standards Board (FASB) changed the mark-to-market rules last week, which many thought was needed. First, they suspended the mark-to-market rules for assets in distressed markets. Second, they widened the definition of "temporary" impairments of troubled assets, which will "allow banks to write up the value of some troubled assets if these have been hit by falling markets without (yet) suffering any significant credit losses."

Here's the important part. The board decided to make the new changes effective immediately, prior to full board approval on April 2.

As my friend Charles Gave noted, this will allow banks to write up their paper, and it happens before Treasury Secretary Tim Geithner starts putting taxpayer money at risk. Expect to see a pop in valuations. It will be interesting to see if Citi and B of A post profits this quarter.

(I should note that the International Accounting Standards Board sent out a scathing press release. I guess from that we should assume that European banks will not be so fortunate as their US counterparts.)

I disagree with John Mauldin on this for these reasons:

• One of the primary causes of this entire financial crisis was lack of transparency of these exotic derivative financial instruments. There was not market, no liquidity, and no transparent pricing mechanism for them. The imposition of mark-to-market accounting was to force these instruments to be valued on a more transparent and real-time basis, just like the various exchanges do with their products (stocks, futures, bonds, etc.). By eliminating this accounting standard, we are literally recreating the causes that created the crisis in the first place. We are making them less transparent, not more so. This is no solution. It is delaying the inevitable accounting. It is also injecting -- delaying -- more systemic risk back into the financial system. It is nothing but a delay tactic. It doesn't solve the problem.
  
• It assumes that economic circumstances will improve in the medium to long term -- months, not years. What if is doesn't? The whole premise of the assumption could be wrong! If it is wrong, it will only make the final accounting that much worse when the piper must be paid.
• It allows weak financial institutions to artificially inflate the worth of their stock and the value of damaged and distressed assets. It also deceived investors into believing that these banks are healthy, when in reality, they are insolvent.