Banks struggle to put their house in order ... before outsiders do it for them
How will securitization shape up?
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Lloyd Blankfein, Goldman Sachs: Disagreed with IIF on making to market |
The CEO says: "The management of accounting rules today is a scandal. It is as if the ayatollahs are running the world and imposing their own theoretical values. These are both highly pro-cyclical and non-economic. By insisting on running mark-to-market accounting through the profit and loss, we are living in the economy of the instant. There is no attempt to integrate the different time horizons of different types of institutions. If you take a six-month or two-year view on certain assets that may be how you manage your company, but you’ll be reporting for the instant.
"So with CDOs for example, if Merrill Lynch sells some of its holdings at a fire-sale price, others will have to take account of that, even if they are under no obligation to sell at the same time in the same circumstances and even if they are prepared to journey across the desert of analysts’ and shareholders’ disapproval because they see cashflows on their CDOs staying current and believe values will be higher in six months or two years.
"This is not good for markets and it is not good for the economy. To have efficient markets, you need different investors taking different views. Forcing P&L recognition of day-to-day valuations imposes a harmonization that makes markets less efficient."
The CEO is perhaps talking his own book but his passion is obviously born of complete faith in his argument. Euromoney thinks better of raising the topic of how to calculate mark-to-market values when no functioning markets exist for certain assets.
Others hold an equally adamant opposing view. Goldman Sachs quit the Institute of International Finance this past summer when it came to believe that the IIF’s market best practices report was leaning against the recognition of mark-to-market accounting.
When Lloyd Blankfein, CEO of Goldman Sachs, spoke to Euromoney earlier in the summer (The franchise: Why Goldman Sachs is in a league of its own, Euromoney, July 2008), this controversy was still fresh in his mind. If Goldman’s traders whine to their controllers that there are no buyers and a market is not functioning, the controllers tell them to lower the price and they’ll soon find the market.
Blankfein said at the time: "There is no point saying the theoretical value of an instrument is 94 but, unfortunately, the supply/demand paths cross at 52. What that means is that it’s worth 52." And while accepting that valuations might be difficult when there are market disruptions, he added that still: "It makes no sense to record an asset at an historical price when, given market circumstances, you know it’s not what you could sell it for today."
The IIF has been highly circumspect in all this, producing lots of recommendations on the governance of the valuation process and sourcing of price inputs but on the most contentious issue rather lamely saying that firms should have valuation processes in place for times of market stress that encompass how to recognize when changes in market liquidity require changes in valuation approaches; that they should follow objective and controlled procedures for placing assets in the trading book (where strict mark-to-market accounting is required) or the banking book (where it is not) and be able to provide clear explanations for why assets initially placed in the trading book should be moved to the banking book.
Wise heads at the IIF appear to have concluded that it is such a fundamental and potentially inflammatory debate that the middle of a huge financial crisis is not the time to hold it. Banks do not want to send any signal that they are desperately seeking relief from strict mark-to-market approaches only now that asset prices are falling for fear that this be interpreted as showing that they are hiding even worse losses to come than those already reported, so further unnerving investors as the industry continues its efforts to recapitalize.
Discussion is much needed on the price at which assets should be recorded as they transfer from the trading to the banking book, on whether there should be a new intermediate book, where assets might not be subject to daily valuation and P&L accounting but would have to be sold and marks accounted within, say, two years.
The debate has to take place. And the IIF says that banks should participate in efforts with the official sector and standard-setters to develop meaningful, comparable disclosures on valuations, valuation processes and methodologies and uncertainties associated with valuations.
When you write that down and look at it, it comes across as mealy-mouthed. If that debate still lies ahead, what should banks do now?
Deutsche Bank chief executive Josef Ackermann says: "It is important to align risk management with accounting, so that, if a bank warehouses loans for future securitization in the trading book and then gets stuck with them, it considers not just the likelihood of default on those loans, but also the P&L impact of markdowns as a result of a spread widening."