Wednesday, April 1, 2009

Are Mark-to-Market and PPIF at Odds?

Posted on Wall Street Journal MarketBeat by David Gaffen:

It’s expected tomorrow that the Federal Accounting Standards Board will vote to officially relax the mark-to-market accounting rule that requires banks to write down the value of assets to observable market levels. But this would seem, in some way, to obviate the purpose of the Treasury Department’s public-private investment fund designed to buy up the very assets in question off banks’ balance sheets.

As Heidi Moore, Deal Journal warrior goddess, relates in today’s Wall Street Journal, the changes are being made to assist U.S. banks, which have complained loudly that current rules force them to undervalue their assets – and that has led to a subsequent crisis of confidence in the banks among investors.

Putting aside for the moment whether the removal makes sense or not – and there are supporters on both sides – if the banks are suddenly allowed to mark their assets to levels that they deem sufficient if they plan on holding said assets to maturity, then what is the point of the program to buy up those assets?

“Both plans have positive aspects,” says Dan Ripp, president of Bradley Woods, a policy research firm in New York. However, he says, the mark-to-market rules should have either been adjusted a long time ago – or after the PPIF program “had a chance to work its magic.” Instead, now, “it may be moot…the banks are out of the storm and can afford to hold the toxic (Level 3) securities much longer.”

There are two components to the Treasury’s plan. The first involves so-called legacy securities, which have largely been marked to lower values. Any buyers of those securities through the extended Term Asset Liquidity Facility are unlikely to want to pay more just because accounting rules have been relaxed. It also opens the possibility that “you could have a bank which made its best efforts to mark an illiquid opaque investment or security, and now it could result in a transaction that, because of the auction process which introduces the use of federal credit, results in a profit to the selling bank,” says David Kotok, co-founder of Cumberland Advisors in Vineland, N.J.

The second component involves the legacy loans – which have not been marked down, and will require substantial government leverage in order to satisfy both the banks and the buyers of these securities. If banks don’t get a deal they like, they may elect to hold the securities instead. And then investors are back to the same problem – the banks, now viewing these securities at different values, will have different estimates of their health.

But that doesn’t mean investors have to agree. “Market participants have been tearing apart the financial companies,” says Linda Duessel, equity market strategist at Federated Investors. “Say what you want about their value – but the market will decide anyway.”

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