By way of background, FASB changed accounting rules in late 2007, forcing financial firms and auditors to use “observable,” market prices to value many securities rather than models or cash flow. According to Milton Friedman, rules of this type helped cause the Great Depression. So, it is no surprise to us that within a year of their return, by late-2008, the U.S. experienced its first financial panic in a hundred years.
We have written extensively on this subject, but the number one problem with fair value accounting is that market prices for assets are forward-looking. In good times, prices reflect a positive outlook. In bad times, they reflect a negative outlook. And when markets freeze up, financial institutions must use prices that do not reflect actual cash flow. This forces losses on the system that are not yet real. The FASB rules create a vicious downward cycle of losses, bank failures, more fear and lower “observable” prices, more losses and more bank failures.
All the TARP and money, interest rate cuts, government stimulus, stress tests, and Fed balance sheet expansion in the world, cannot stop this downward spiral. That’s why the markets kept falling until March 9, 2009, when a Congress started to twist arms on the issue. FASB was forced to correct its rules and allow cash flow to be used when markets were illiquid. Just this small change did the trick. Banks were finally able to raise new capital, the stock market surged, and the economy quickly headed for recovery.

Despite this unmistakable evidence that accounting rules were the culprit, FASB is not admitting a mistake. Instead, it is doubling-down on this rigid and ideological accounting fundamentalism. FASB wants to mark bank loans to market.

But there is no real market for bank loans. The value of any loan is always in the eye of the beholder. As a result, “who” is doing the beholding determines the viability of an institution and maybe even the health of the economy. How does a trader in New York, know what price to bid for a loan to a dry-cleaner in Burlington, Iowa? In fact, the minute a bank makes a loan to a local small business it will be forced to write down the value because no one else will pay 100 cents on the dollar for that loan, especially in times of economic stress.

To be clear, the financial system and economy are much healthier now than they were in 2008, when home prices were over-valued. This rule is pro-cyclical and right now the cycle is pointing up, not down. But when problems do come again (as they always do), this new rule, if implemented, could turn a brushfire into an inferno, causing capital to fall and banks to stop lending (and even sell assets) at just the wrong time.
Fair value accounting ties the balance sheet of the economy (the value of assets) to the income statement and capital accounts. Because the balance sheet is bigger, a small ripple in asset values creates a tsunami when applied to the income statement. Instead of reducing risk, fair value accounting has an unintended consequence of increasing the cyclicality of the economy – which, by definition, increases risk.
And without risk-taking, growth suffers. FASB must cease and desist in this endeavor. They have asked for public comment, we suggest you comply.

There is little doubt by either political party that something must be done. Since 2000, Illinois’ annual spending has grown by more than 20 percent while the economy has grown by only 12 percent. Illinois’ debt has grown by more than 57 percent over the same period. Every man, woman, and child in the state now owes the state’s creditors $4,125.

This burden has effects on the state’s economy. Illinois is the sixth worst state for private sector job growth. If no jobs are being created, people tend to leave. Over the past 10 years, the only two states to lose more people than Illinois to domestic migration are New York and California.

As people leave and spending continues to spiral upward, the debt burden on taxpayers goes up. It’s a vicious circle that cannot be solved by tax increases, which only deepen the problem by discouraging economic growth.

But there is another, more fundamental budget problem in Illinois. Our budgetary process is broken. Illinois is constitutionally obligated to produce balanced budgets. Despite this, Illinois debt grows more with each budget. According to the Institute for Truth in Accounting (IFTA), this is because the governor, the comptroller, and the General Assembly use a myriad of accounting tricks, nontransparent procedures, and, in some cases, a total subversion of the law in order to pass their budgets. For example, the IFTA provides evidence on its Web site that the state government fails to provide revenue and expenditure estimates in accordance with the State Budget Law.

Recently, Quinn announced he is borrowing money from the state’s road fund to reinstate about $200 million to the education Monetary Award Program (MAP). But the money still needs to be accounted for regardless of where it comes from. “Switching money from one pocket to the other is not going to solve it,” said the Institute for Truth in Accounting’s CEO Sheila Weinberg.

Illinois can no longer pretend it has a balanced budget and can no longer give its politicians the power to obscure their accounting games.

How can we solve the budget deficit when we don’t really know the scope of the problem? Before the General Assembly reconvenes in January for the 2010 legislative session, we need to have an honest discussion about the system of waste, fraud and abuse that exists in Springfield. Americans for Prosperity believes that any proposal that looks at tax increases or archaic cuts first is missing the true problem in Illinois: a lack of fact-based budgeting.

Only with a true picture of our total expenditures and revenues can we begin to discuss solutions to our financial woes. Illinois needs budgetary reforms how and fact-based budgeting is the first step.
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Joe Calomino is state director of Americans for Prosperity-Illinois.

Bloomberg announces it this morning.

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 approved today to fair-value, also known as mark-to-market, allow companies to use “significant” judgment in valuing assets to reduce writedowns on certain investments, including mortgage-backed securities. Accounting analysts say the measure, which can be applied to first-quarter results, may boost banks’ net income by 20 percent or more. FASB approved the changes during a meeting in Norwalk, Connecticut.

Couldn’t FASB have done this before the elections?

Note: Photo is the Baltic Exchange, whose freight index which has risen 50% this year.

   The early signs of a revival in velocity were evident a couple months ago, before a dollar of new government spending got out the door.  Commodity prices, such as oil and gold, the Baltic Freight Index (which measures ocean freight rates) and used car prices, all bottomed.  But the coup-de-grace was last week when retail sales surprised the talking heads for the second month in a row.

   After January’s 1.0% rise in retail sales, TV pundits said seasonal factors distorted the data.  But, last week January sales were upwardly revised to 1.8% growth.  After a strong month like that, retail sales often give some back.  But in February, even though auto sales fell 4.3%, total sales only gave back a small 0.1%.  Excluding autos, February sales shocked the pundits and rose 0.7%.  In the past two months, retail sales (including autos) are up 10.7% at an annual rate, while retail sales (excluding autos) are up 14.8%.  Chain store sales in February were the highest since last September.  Slice it anyway you want, but the consumer is coming back.  This is something to write home about.

   Normally, business investment is the key driver of the business cycle.  But when the economy is ravaged by a loss in velocity – literally, the speed with which money makes its way through the economy – a revival in consumer spending is the key leading sign that the economic pain is soon coming to an end.

    Even overall inflation data has shifted.  Consumer prices fell at a 12.4% annual rate in the last three months of 2008, but were up at a 3.4% annual rate in January.  I expect a similar increase in February (CPI out Wednesday).  The same goes for producer prices (due Tuesday).

   And after a rare decline in nominal GDP – real GDP plus inflation – during the fourth and first quarters, I expect the second quarter to turn up.  This severely undermines the case that monetary policy is too tight.

   Meanwhile, perhaps the best news from last week came at a Capitol Hill hearing on mark-to-market accounting.  At that hearing, key lawmakers, including House Banking Committee Chair Barney Frank and Rep. Paul Kanjorski, strongly urged accounting rule-makers to get their act together.  Last year, despite warnings from many (including Steve Forbes, William Isaac, Gary Wolfram, and here at First Trust), the accountants made only superficial changes to the rules, and as a result, took an historically average financial market problem and converted into the greatest financial panic since at least the Great Depression.  But now, Congress has said no more.  The heat is on, and this time I can’t imagine that FASB and the SEC will disappoint the markets again.

   To top all this off, what appeared to be an un-impeded march toward even more federal government spending, even higher taxes and even more economic interference seems to have finally hit a bi-partisan road block.  No wonder the stock market is showing signs of life.

More from Brian Westbury Here
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Brian Westbury is Chief Economist at First Trust Portfolios and a regular contributor to the Chicago Daily Observer

The head of the Financial Accounting Standards Board (FASB) — which, along with the SEC, oversees corporate accounting — told a House panel today that “in three weeks” his organization will issue new guidance on mark-to-market rules, allowing financial firms some flexibility in accounting for the toxic assets poisoning their balance sheets, the Associated Press is reporting.

Read more at the Washington Post

The Omaha oracle, in his appearance this morning on CNBC, called for suspending mark-to-market accounting for purposes of determining whether banks meet regulatory capital standards. He also argued that with sweeping guarantees of depositors and bondholders in place, there’s no need for government capital injections: Banks should be allowed to earn their way out of trouble based on the princely spreads now available, which they can readily do.

Read More at the Club for Growth

1) End Mark to Market Accounting
2) Revive the Uptick Rule
3) Reduce speculation on Credit Default Swaps

each of which should lead to reduced volatility in financial stocks. As Stein puts it

“Now, some of the decline in the financial markets is occurring for a very good reason: real concern about profits and coupon payments. But some of it is simply a result of the internal workings of the markets, which are pushing securities relentlessly down.”

Predictably the self depreciating Stein was ridiculed for his suggestions by the esteemed Conde Nast Portfolio.com. But Stein realized that hearings were to be held this week discussing accounting regulation. So today, when Barney Frank gave a nod to some regulatory reform, the markets reacted in a very favorable manner, with the Dow jumping 379 points or 5.8%.

Imagine the reaction if Congress would actually implement some accounting reform, or scale back tax hikes or reduce spending. Here’s to a change in course!

More on Mark to Market at the Chicago Daily Observer

That works when you have very liquid securities, such as Treasurys, or the common stock of IBM or GE. But when the credit crisis hit in 2007, there was no market for subprime securities and other suspect assets. Yet regulators and auditors kept pressing banks and other financial firms to knock down the book value of this paper, even in cases where these obligations were being fully serviced in the payment of principal and interest. Thus, under mark-to-market, even non-suspect assets are being artificially knocked down in value for regulatory capital (the amount of capital required by regulators for industries like banks and life insurance).

Read more at the Wall Street Journal

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