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Former FDIC Chief: Fair Value Caused the Crisis

Things were fine before the accounting standards-setters barged in and "destroyed hundreds of billions of dollars of capital," he contends.

David M. Katz, CFO.com | US
October 29, 2008

BitingCommentsAsideUrWrong

Most of the comments regarding Fair Value Accounting don't get it. Point A former Government Official who was involved in the banking crisis of the 80s said that if we used FV accounting then all the commercial banks would have failed. Point Unlike the thermometer analagy, the effects are self fulfilling on this patient. Bad analagy. Chemo would be a better analagy, where the treatment almost kills the patient. Point Mark to Market accounting CAUSED the bubble. Don't thinks so ? How else could a buyer of a house in Las Vegas finance a house for $700k that sold for $400k only a few years earlier ? Mark to model should be used on all borrowing even margin on stocks. Cash flow value should determine what lending amount should be. Then the house in Las Vegas for $700k only gets $400k in mortgage loan because Rent amounts say that is what the house 'should' be worth. At the peak Las Vegas houses were renting for a 1% yield. Unsustatinable. Mark to market fails here doesn't it. And that stock market bubble. Cash flow value on CSCO was $18 in 2000 even though the stock was at $80. Of course if margin had been against $18 instead of $80 the bubble may never have happend. Once again Mark to Market shows its flaws. The answer is mark to model and INDEPENDENT auditors and accounting firms that you cannot fire without cause. Where are you rationale arguments against these statements ? Real life situations and theoretical purists don't often match.

Posted by Jay Edward | November 11, 2008 03:15 am

FDIC Comments on Fair Value

Before the FDIC (and others) blame fair value accounting for the financial crisis, they should first recognize that bankers (especially mortgage bankers) wanted to use "fair value" to help them recognize earnings by booking the fair value of servicing rights and other assets. Fair value was fine when people could use it to recognize earnings based on paper gains (and assets) and then are complaining having to write down these paper gains and assets.

Posted by John Day | November 06, 2008 03:20 pm

Unbelievable...Typical Politician

Poor mortgage lending practices caused the crisis and inaccurate ratings allowed distribution. Start with Fannie and Freddie May, weak cash flows to service debts, inaccurate S&P / Moodys ratings, and too low of interest rates by Fed. Result, witchs brew. Possibly: deflection & "smoke" tactics being used by a Politician.

Posted by Jim Collins | November 06, 2008 12:29 pm

Debt Levels

Form over substance is often a debate in accounting. The form of the abuse of logic is really a symptom and not a cause of the current crisis. The current crisis was CAUSED by debt growth that far outpaced income growth. This was meaningly facilitated by the disintermediation of banks by the capital markets. However, it was the specific objective of monetary and fiscal policy to incite demand growth through the expansion of credit. The expansion of credit has disproportionately occurred in non-productive sectors such as housing and financial credit. As such, the bulk of new credit which fueled demand growth was not self-liquidating (incomes were not enhanced as a result of the expansion of the capital stock) although it allowed the mark to market gains in housing to be sold at the margin from homeowners to banks and MBS investors and those gains were "consumed". Until a proper diagnosis of CAUSE is accepted, you will see knee-jerk responses that address phantom causes but which do not prevent the next credit bubble from occurring - they will only change the way they occur.

Posted by Kimbell Duncan | November 06, 2008 06:57 am

No one raised their hand!

Speaking of models; rather mark to mystery models; precisely Watson - during 2004 thru 2007 not even one of the masters of the financial universe (MOTFU's) raised their hand and proclaimed "GEEZ MY BONUS CHECK LOOKS TOO LARGE - better double check it" this in the era after SEC relaxed rule 15c3-1, effective Aug. 20, 2004 to allow the alternative (self determined) calculation of net capital purportedly in exchange for the SEC getting "total" access to a Broker Dealers books; listen to the audio of that meeting at sec.gov - astounding...btw, just for fun, anyone happen to catch the Saturday, August 9, 2003 NY Times article (buried on like page 5) wherein insurance carriers announced they would NOT renew broker dealers "excess SIPC" coverage; a risk upon which they had NEVER paid out on a claim...things that make you go hmmmmm. It's not about being right or lucky - it's about recognizing the obvious - U.S. REAL ESTATE has a 200+ year record as an asset class up to 2002 - THEN WHAT? hockey stick to the north - moral of story - watch out for hockey sticks especially those whose securities and entities are IN THE DARK and smeared with LEVERAGE of 20, 30, 40 to 1 - and that's on a reported / model (not actual) basis!

Posted by Chris McConnell | November 05, 2008 10:55 pm

Blame the Messanger

All the accountants have done is shine the light of truth on the internal rot that was already there. If you look at the complete history of Fannie Mae and Freddie Mac and the Community Redevelopment Act, you will see that many people have been trying to raise the alarm. The potential for financial disaster has been raised as an issue since at least 1997.

Posted by Mark Gottfried | November 05, 2008 09:42 pm

Specious nonsense

Blaming fair value is a great example of the intellectual dishonesty that pollutes the real debate.

Posted by Dennis Howlett | November 05, 2008 08:28 pm

Pass the Blame: deflect the real cause

This guy is out in left field. House prices were overvalued because people could get a mortgage when they did not qualify. As soon as the low interest start of the mortgage was over these people could not pay it. They then walked away from the house and this started the snow ball effect. Look at the Canadain Banking system. Not one bank has failed or even close because these banks could not offer sub prime mortgages. Plus GAAP in Canada calls fo the same fair value account on these assets.

Posted by Mark Steppell | November 05, 2008 08:12 pm

confused

Everyone I've heard rail against MTM accounting from the banking/finance industry has, in effect, said one of two things: (1)that MTM isn't real economic value because the assets could be held to maturity, thus the losses are paper losses. My understanding of SFAS 115 was that if you have the positive intent and ability to hold an investment to maturity, then you only had to recognize a writedown in value if the decrease in value is other than temporary. Clearly, I'm missing something. or (2) they're being forced to write assets down to the most recent trade in an illiquid market, a trade which may have been executed at an inappropriately low price considering the illiquidity of the market. My understanding of SFAS 157 is that no one factor should determine your value, if you're valuing level 2 or 3 assets. Now, if auditors are being ultraconservative and forcing that kind of valuation, that's an auditing issue, not an accounting rules issue (and the root cause of that ultraconservative stance should be studied). BTW, I love the thermometer comment. Nice.

Posted by Jerome Kern | October 30, 2008 04:26 pm

margin calls

I'm sorry to say that I had stock in a mortgage company that got crushed early in the credit crisis. It got crushed when it couldn't meet a margin call. It couldn't meet the margin call when market prices for the collateral that it had posted dropped in February. The creditors were there with their margin call almost immediately. There was no mark to market financial statment issued. This happened within a quarter. The creditors were not relying on the December 31 finanical statements. Instead they were relying on their own observations of market prices. It was not mark to market accounting, and not mark to market based financial statements, that crushed the company. It was margin calls. One could easily have had mark to market accounting and financial statements, but if not for the margin calls the company would still be in business. I think it better to outlaw margin calls than to outlaw mark to market accounting.

Posted by Roland Cycan | October 30, 2008 02:18 pm

Once upon a time...

This is the story I will be telling my children one day. Once upon a time in American history... There were a million losers who borrowed money for a mortgage and couldn't make their payments. The banks who lent the money knew that these people were losers and wouldn't ever be able to pay it back. And the Clinton Administration set the whole thing in motion by proposing that more people- losers who couldn't afford them- own their own homes. The dead-beats didn't make their payments. Banks went bankrupt and my tax dollars (which should be funding new schools and better health care) helped bail out these self-centered morons. To top it all off- for some crazy reason, certain people blamed the profession of Accounting- instead of blaming the people involved for the big mess. And that, my friends, is how it all went down.

Posted by Shannon Givler | October 30, 2008 10:59 am

Hear No Evil, See No Evil...until Evil is Exposed

The Fair Value rules needs refinement, I believe that there is agreement on this point. To say however that the tools that uncovered or exposed the unethical, greed-based, decisions, actions and behaviors, that have landed us where we are - are the reason for us getting here, is well, very unwise. Yet it does uncover the kind of thinking that laid the ground-work for all of this: Do not let the right hand know what the left hand is really doing.

Posted by Craig Ferguson | October 30, 2008 10:58 am

YOU CAN'T BE SERIOUS ! !

MARK-TO-MARKET ACCOUNTING HAS BEEN IN EFFECT FOR WELL OVER 40 YEARS. . . IT HAS WORKED and IS OPTIMAL WAY to PRICE ASSETS . INVESTORS and INVESTMENT PROFESSIONALS OVER-LEVERAGED and DID NOT WANT TO UNDERSTAND and ACCEPT THAT MARKETS FLUCTUATE ; THEY DID NOT ANALYZE RISK CORRECTLY and GOT CAUGHT. THIS IS UNPROFESSIONAL CARELESSNESS ! ! SO STOP CRYING ! ! I FIND IT RIDICULOUS THAT HEDGE FUND MANAGERS BOAST OF THEIR RETURNS, BUT THEY DO NOT ABIDE BY THE LEVERAGE RULES OTHER INVESTORS HAVE TO ABIDE BY. . . . THEN WHEN MARKETS CORRECT, THEY BLAME THE MARKET - - NOT THEMSELVES - - "FAIR VALUE" ACCOUNTING PRACTICES SHOULD BE MAINTAINED . . . "MARK-to-MARKET" ACCOUNTING is THE PROPER WAY TO ACCOUNT for ASSETS ! ! JAMIE DIAMOND POINTED OUT on CHARLIE ROSE that THE LOSSES SUFFERED WILL BE "REALIZED" and THEY ARE NOT JUST a TEMPORARY EFFECT of an INEFFICIENT MARKET ! ! MARK-to-MakeBelieve IS OUTRAGEOUS ! ! !

Posted by Thomas McCarthy | October 30, 2008 10:52 am

Fair Value Accounting and the Credit Crisis

If Mr Isaac has concluded the current credit crise is solely a product of fair value accounting, and is unable to think of any other cause, he has chosen to ignore poor credit due diligence and underwriting and overly generous credit rating. Credit evaluations ranged from minimal, through non-existant, to fraudulent. Collateralized groups of morgages were mis-rated and poorly understood. His current affiliation has a dog in the fight as placing the blame on accounting rather than bad business practice is convient for his business.

Posted by Barrett Peterson | October 30, 2008 10:45 am

Non-Systematic valuation process

Does'nt is seem odd that for Accounting (FASB/IASB) and Tax (Treasury/IRS) I can go to applicable industry criteria (i.e. FAS 91) or a Revenue Ruling - but for valuation there is no systematic approach. One of the foundations of value is supply/demand. If the demand is being driven by artifical stimuli (lower credit standards) then valuations should provide the impact from that stimuli in the appraisal/forecast. This gets back to risk management and the industry understanding the drivers of value that impact industry/assets.

Posted by Mark Belec | October 30, 2008 10:29 am

Non-Systematic valuation process

Does'nt is seem odd that for Accounting (FASB/IASB) and Tax (Treasury/IRS) I can go to applicable industry criteria (i.e. FAS 91) or a Revenue Ruling - but for valuation there is no systematic approach. One of the foundations of value is supply/demand. If the demand is being driven by artifical stimuli (lower credit standards) then valuations should provide the impact from that stimuli in the appraisal/forecast. This gets back to risk management and the industry understanding the drivers of value that impact industry/assets.

Posted by Mark Belec | October 30, 2008 10:29 am

The Cubs Lost because of historical accounting methods

Had the cubs scorekeepers been able to apply 157 to the performances of the various athletes involved in the games, they may have won the World Series. Instead, they were forced to measure their performance based upon actual transactions, not the estimates of others. Or rather, they were forced to measure based upon historical accounting rules. (Does anyone understand how ENRON managed to pull off its fraud. SPE's and market valuations were heavily involved.) I've performed about ten minutes of research. The following links, all at CFO.com, provide a brief historical discussion of the pitfalls foreseen with the advent of fair value accounting. (Why did the SEC insist on historical accounting principles in 1934?) Although it is effective for reporting years starting after 11/15/2007, if you were planning on using it at 12/31/2008, FASB wanted each quarterly report to incorporate it throughout 2008. Here are the links: http://www.cfo.com/article.cfm/11287863?f=search http://www.cfo.com/article.cfm/10097878?f=search http://www.cfo.com/article.cfm/3003648?f=search http://www.cfo.com/article.cfm/11367210?f=search

Posted by Charles Smith | October 30, 2008 09:42 am

Ignore the man Behind the Curtain

I cannot recall having heard an allegedly intelligent former official spout such unadulterated equine excrementu in recent times. Gordon Gecko would be proud. So, as I understand what this former FDIC chief is saying, it is not the fact that unscrupulous investment bankers floated garbage securities as though they had real value that caused the problem, it was caused by a new rule that was not applicable to all and that would have required disclosure that such securities were valueless. Ignorance is bliss? Oh, please!

Posted by | October 30, 2008 08:18 am

Now I know why the Cubs lost in the playoffs`

It was the scoreboard operator not the pitching or the fielding or the hitting. We seem unable to deal with the fact that our booming economy was - and may still be - dependent on getting folks to buy things they don't need by going into debt. It's been one big ponzi scheme and, like all of those, it's finally collapsing.

Posted by James Fuehrmeyer | October 30, 2008 08:17 am

We need a better lobbyist

Obviously us CPA's aren't giving big enough campaign donations these days. Clearly, the people who don't want to accept responsibility for the mess that they have made determined that people don't understand enough to realize that they are blaming the "effect" for the "cause". Unfortunately, many people will believe this because they don't understand and they want to point the finger at someone else. The problem can't possibly be the borrowers who couldn't pay their mortgage payments, or the lenders who gave money to people without any indication that they could pay the bill, or the politicians who created public policy to encourage this mess. Now we have a nation blaming the alarm system for the bank robbery. I guess some would rather just keep their heads in the sand and pretend like nothing is happening.

Posted by Nathan Leaphart | October 30, 2008 08:12 am

KILL THE MESSENGER

Of course everything was fine until the Surgeon General said smoking was unhealthy, or the radar spotted your speeding, or Moises came down with the Ten Commandments, or somebody came up with the idea that after three strikes you are out. Come on now, the problem is not the rule but the "rulees"

Posted by Carlos Baez | October 29, 2008 09:19 pm

Great OBSERVATIONS!!!

All The responses were terrific and dead on the facts. The problem is that there are individuals in Congress and else where that will actually believe his drivel. Oh Well. It will be "fun" working through this mess for the next few years. Hopefully, most of the companies on the NYSE will still be owned by a majority of Americans in 2010.

Posted by Jeffrey Bartlett | October 29, 2008 08:31 pm

FAS 157?

How can FAS 157 be the problem when it is not yet manadatorily effective? Of course companies can elect early adoption, but it is effective for years beginning after 11/15/07 - essentially 12/31/08 year ends.

Posted by Steven Coleman | October 29, 2008 08:24 pm

FMV the Problem? Of Course NOT.

"I gotta tell you that I can't come up with any other answer than that the accounting system is destroying too much capital, and therefore diminishing bank lending capacity by some $5 trillion," he asserted. "It's due to the accounting system, and I can't come up with any other explanation." How can representational faithfulness and currency of the financial statements be at fault as the underlying problem? Financial statements do not act alone in some phantom world. The real culprit is corporate greed and incompetent debt decision granting along with poor investment decision making. That and a severe lack of banking independent regulation. Let's not sugar coat with a right wing response of FMV as the cause of the current economic crisis. Let's get to the radical truth by thinking critically!

Posted by David Newman | October 29, 2008 08:12 pm

Subtimus Prime

Maybe it was only a small problem back then because we didn't have to look and see how big it was.

Posted by Cody Yost | October 29, 2008 07:52 pm

FMV? Of course!

Of course FMV accounting is responsible. It has nothing to do with 1) highly complex/opaque financial instruments that are 2) difficult to refinance/unwind and 3) derive value from bubble inflated housing prices that were valued by 4) appraisers that were paid by the house and 5) purchased by housing investors with historically low downpayments or 6) subprime/At - A home purchasers lying about their ability to pay through 7) insanely risky home mortgages (Option ARM = wtf?) that were 8) packaged and sold by investment banks for the fees and not maturity which were rated by credit rating agencies that made 9) system rating errors, 10) made money on volume, or 11) were just plain wrong. I could go on about 12) simple greed, 13) insane leverage ratios, 14) government policy 15) herd mentality or 16-*) any one of a thousand other reasons. But since accounting is a rule and rules are easy to change, it is FMV accountings's fault. Thats why I blame my thermometer when I'm sick.

Posted by Thomas Gavlin | October 29, 2008 06:43 pm

Blame Negative Numbers

I blame negative numbers. After all, without negative numbers, one cannot have losses--ergo, no losses to report--ergo, no subprime mess. I demand a full investigation into Diophantus, who once warned that calculations requiring the use of negative numbers were absurd. Thankfully nobody takes fools like William Issac (or should I say Keynesian economists) seriously anymore.

Posted by Jason Budd | October 29, 2008 04:16 pm

Blame the Mountain

Mr. Isaac's argument is like blaming the mountain for a plane crash. There we were, zipping along at Mach 2 and everything was peachy when "BAM!", that darn mountain reached up and smashed us. Let's just give the drunk pilot another scotch and assume that mountain away. His comment that litigation adverse audit firms may have been overly conservative (remember when that was a virtue for accountants?) is worth exploring further, but at the moment it looks like they were dead on or generous.

Posted by James Wall | October 29, 2008 03:56 pm

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