About the Politically Malleable FASB, Paid for Politicians, and Mark to Myth
Johnathan Weill has an excellent article on Bloomberg today illustrating just how BS the BS FASB accounting changes regarding mark-to-market really were. For all of those who wondered why I have stayed so bearish on the banks, stay tuned, but before we read this oh so interesting story, let me provide you with a graphical recollection of recent history via this chart sourced from Bloomberg:
If the engineered bear market rally is running off of the FASB generated lies, then we certainly do have another crash coming, don't we?
Feb. 25 (Bloomberg) -- Next time you see some company complain its "mark-to-market" losses aren't real, remember this name: the Federal Home Loan Bank of Seattle. It used to claim that, too. And it couldn't have been more wrong.
About a year ago, the government-chartered lender blamed accounting rules after it wrote down its portfolio of mortgage- backed securities by $304.2 million to reflect how much their fair-market values had fallen. While those declines counted against its earnings and regulatory capital, the bank said they were "well beyond any expected economic loss."
The bank's executives said they expected to lose a mere $12 million of principal over the life of the securities. That estimate proved far too hopeful, though.
The bank, one of 12 regional Federal Home Loan Banks that supply low-cost loans to about 8,000 member banks and finance companies, now says it expects about $311.2 million of credit losses on its portfolio. And in December, it filed lawsuits against 11 Wall Street underwriters, including Goldman Sachs Group Inc. and Morgan Stanley, seeking more than $3.9 billion of refunds on the securities, plus interest. You know the losses are real when the bank is suing to get its money back.
As you can see from my table below, FHLB Seattle execs were obviously engaged in one of those wicked sensimilia sessions when they came up with that $12 million dollar loss figure, and over the entire loss of the securities may I add, not even for just one quarter.
This is the question of the day. How in the hell can FHLB Seattle accuse GS, MS, et. al. of wrongdoing when they themselves stated that they expected minimal losses on these securities/loans and the blame for the losses belong to mark-to-market accounting and not to buying leveraged real estate products at the top of a bursting real estate and credit bubble???!!!! Hey, if you allege that the investment banks lied, that probably means you lied as well - and we all know you LIED! Of course, you could have just made an error, but then again so did the crooks banks that sold the trash products to you. Back to the article, cause it gets better...
Yet there's a far greater outrage here than this one bank's unpleasant surprise. That would be what transpired in Congress and at the Financial Accounting Standards Board last year after the Seattle bank disclosed its rosy $12 million estimate, which soon took on a life of its own.
The bank became a poster child for everything supposedly wrong with mark-to-market accounting. At a March 12, 2009, congressional hearing, U.S. Representative Ed Perlmutter of Colorado cited the disparity between the bank's writedown and its much smaller anticipated [emphasis added] loss as "an example that really was disturbing."
The congressman leading the hearing, Paul Kanjorski of Pennsylvania, pointed to a similar instance at the Federal Home Loan Bank of Atlanta. The bank reported an $87.3 million writedown on its mortgage-backed securities for the 2008 third quarter; however, it said it expected its actual losses would be only $44,000.
While that's roughly equivalent to the losses from a modest studio condo foreclosure, Kanjorski didn't question the tiny number, saying: "I find that accounting result to be absurd."
"It fails to reflect the economic reality," he said. "We must correct the rules to prevent such gross distortions." Kanjorski, Perlmutter and other lawmakers told Bob Herz, the chairman of the FASB, that it needed to change its rules immediately so banks could show stronger earnings. The board, which fancies itself as an independent standard setter, complied a few weeks later.
Changing the Rules
The rest of the story: Last year when the Atlanta bank released its financial results for the third quarter, it said it had raised the credit-loss estimate to $263.1 million. (Here's the math in case you missed it: $263.1 million > $44,000.)
No, I didn't miss it. As a matter of fact, I feel the need to elaborate...
Even before the estimate, it was evident that the bank felt the need to declare more losses permanent and to recognize more losses in earnings. Translation, even they realized the jig was up. But what happened to the $44,000 loss estimate? They only expected ONE house to be foreclosed upon, right???!!!
The FASB rule change gave companies a new way to avoid counting paper losses from toxic debt securities in their earnings. Before 2009, whenever companies recorded writedowns on impaired securities that they labeled as held-to-maturity or available-for-sale, they had to run the full amounts through net income for any losses deemed to be "other than temporary."
Now they get to separate the impairments into two parts: estimated future credit losses and everything else. The first kind reduces earnings and regulatory capital. The other doesn't.
Here's how it works in practice. When the Atlanta bank reported its results for the first nine months of 2009, it showed net income of $201.3 million. That included the $263.1 million of credit-related charges. However, it excluded $943.4 million of other mark-to-market writedowns on its securities portfolio. Those got dumped into a line item on the equity statement that banking regulators don't count.
That's how the rules work now, though. The banking lobby got most of the accounting forbearance it was looking for at a critical point in the financial crisis. It didn't seem to matter if the new standard made sense.
For their part, when I asked officials at the Atlanta and Seattle banks why their credit-loss estimates last year were so low, they said the new FASB rules introduced a more stringent test for determining if a security is impaired. Additionally, they said the increases in their credit-loss estimates reflected changes in market conditions, including the performance of loans underlying their securities.
Those explanations aside, what happened here is that a few members of Congress bum-rushed the FASB into action based on a premise that was false, in a misguided effort to boost public confidence in the financial system through smoke and mirrors. It's an open question if the board's standard-setting process can regain its credibility someday. Undoing this disaster of a rule change would be a good start.
So, I had the team pull the data for other than temporary impairments for FHLB and other banks from 1Q08 till there latest reported results. Since the accounting change was applicable for periods after March 2009, we have information for first three quarters of 2009 and the corresponding quarters in 2008. Since many of the banks have not reported 4Q09 figures, we don't have figures for 4Q09 and corresponding figures for 4Q08.
In April 2009, the FASB issued guidance revising the recognition and reporting requirements for other-than-temporary impairments of debt securities classified as available-for-sale and held-to-maturity. As explained in Mr. Weill's article above, the FAS gives significant discretion to the banks in bifurcating other than temporary impairments (OTTI) in the investment value into a) related to the credit loss (charged to the income statement) and b) related to other factors (charged to other comprehensive income). Equipped with the new rule which was effective for periods ending after March 15, 2009, the banks have appropriated significant portions of other than temporary impairments to other comprehensive income which prior to the rule, was entirely charged to the income statement. However, the trends are showing that the proportion that was being transferred to the comprehensive income is declining with many banks and insurers forcibly through fear of being accused of fraud voluntarily reversing the accounting entries made in the previous periods. The same shows how the banks' assumptions about the credit losses on these securities have been changing off late. Do you wonder why? Let me explain it to you with a few pictures from A Fundamantal Investor's Peek into the Alt-A Market...
See "If Anybody Bothered to Take a Close Look at the Latest Housing Numbers...", and in particular the shape of the bubble peak.
The average origination of the Alt-A loan in the use sits right atop that crest. You see where we have went from there...
As if the Case Shiller graph doesn't drive this point home hard enough, the average and mean CLTVs for Alt-A loans AT ORIGINATION hover around 82% to 93%. Those are loans written at the top of the bubble. What do you think happened a few years later???
This is the state of Alt-A loans as of November! Nearly all of them are underwater. Some are totally sunk! We're talking 150%, 175% LTVs. and that is statewide, not anecdotal high end cases!!! If you are not familiar with Alt-A loans, they have a subset known as option ARMs that allow you to pay less than the amount necessary to amortize the loan, resulting in negative amortization. That means as time goes on, your outstanding principal gets bigger, not smaller. Many loans have a cap on this neg am amount wherein if it hits a certain level, the loan goes fully amortizing. What are the chances of this happening??? Well, you tell me.
Current reporting trends show that:
1. All FHLB banks reported the majority of their credit losses (more than 70%) for 9M09 to comprehensive income, with only less than 30% being charged to income statement.
2. Fed Home Loan Bank of Seattle, Federal Home Loan Bank of Atlanta and Federal Home Loan Bank of Chicago transferred majority of their credit losses to comprehensive income during 1Q09 and 2Q09. However, they made a reverse transaction by charging more than 100% of their credit losses to income statement in 3Q09.
3. Fannie Mae only charged 5.4% ($423 million) of its total credit losses for 9M09 to comprehensive income, while Freddie Mae charged 51.6% ($11,928 million) to its comprehensive income for 2009.
4. MBIA transferred 44.4% of its total credit losses ($349.6 million) to its comprehensive income, while AMBAC did not transfer any of its credit losses to comprehensive income over the same period. For those of you who have been following me for a while, I clearly demonstrated how MBIA and Ambace were done for. See
- Are the Mortgage Insurers in Serious Trouble? - 9/3/2007
- A Super Scary Halloween Tale of 104 Basis Points Pt I & II, by Reggie Middleton -11/13/2007
- Tie-in to the Halloween Story - 11/21/2007
- Ambac is Effectively Insolvent & Will See More than $8 Billion of Losses with Just a $2.26 Billion in Equity - 11/29/2007
- Follow up to the Ambac Analysis - 12/4/2007
There is absolutely no way in the world they shouldn't have recognized severe losses early on. The insurers are suing the originating banks for fraud and misrepresentation too. Why? After all, it was mark to market accounting that was causing all of your problems, right?
For the record, FHLB Cincinnati and Des Moines feel that all of the mark downs on their available for sale securities are temporary thus, there were no other than temporary impairments. Sure fellas. As soon we climb right back up to the peak in the graph below...The bubble peak, all will revert back to normal.
One would think the word fraud should come into play here. For all of those that think I was simply lucky for two years in a row on the banks (unlikely) apparently easily believe what you are told by your dear government or are severely balance sheet challenged when it comes to reading said statements. Do any of you really think that the loans sitting on PNC's, Wells Fargo's or JP Morgan's balance sheets are somehow magically different than that of Fannie's or Freddie's?
It appears as if the truth may be forced out at a time when credit markets may be roiled by sovereign debt issues. If so, maybe FASB and certain elected officials should have decided to stop selling their asses to the highest financial bidder and mayhap do the right thing. If losses bust out when the world's credit markets lock up, then we have some serious issues that just weren't worth that damn campaign contribution.
- WFC 4Q09_Review - Public edition (free)
- JPM 1Q 2010 Valuation Review
- WFC Q1-2010 Valuation Update
- GS 4Q09 Final Review and Updated Valuation
- STI 4Q09_Review
- MS 4Q09 results
- WFC 4Q09_Review- subscriber edition
For more free reading on the Pan-European Sovereign Debt Crisis series, see:
- Can China Control the "Side-Effects" of its Stimulus-Led Growth? Let's Look at the Facts - Explains the potential fallout of the excessive fiscal stimulus in China. While not European, it is quite likely to kick off the daisy chain effect.
- The Coming Pan-European Sovereign Debt Crisis - introduces the crisis and identified it as a pan-European problem, not a localized one.
- What Country is Next in the Coming Pan-European Sovereign Debt Crisis? - illustrates the potential for the domino effect
- The Pan-European Sovereign Debt Crisis: If I Were to Short Any Country, What Country Would That Be... - attempts to illustrate the highly interdependent weaknesses in Europe's sovereign nations can effect even the perceived "stronger" nations.
- The Coming Pan-European Sovereign Debt Crisis, Pt 4: The Spread to Western European Countries
- The Depression is Already Here for Some Members of Europe, and It Just Might Be Contagious!
- The Beginning of the Endgame is Coming???