Accounting & Tax

Bernanke: Bailout Would Cool Fire Sales

Although many banks support a temporary halt to mark-to-market accounting, "doing this would only hurt investor confidence," the Fed chairman says.
Alan RappeportSeptember 23, 2008

Federal Reserve Chairman Ben Bernanke today gave the U.S. Senate Committee on Banking, Housing, and Urban Affairs a lesson on how the government’s purchase of distressed assets might produce a market in which true fair-value accounting might take hold.

Along with his co-architect Treasury Secretary Henry Paulson, Bernanke defended the $700 billion federal government intervention they have put together in an effort to stabilize the financial markets by purchasing, holding and, potentially, re-selling the toxic assets that are plaguing the balance sheets of financial institutions.

Although Bernanke opposed the suspension of fair-value accounting rules, he suggested that it’s impossible to right now get fair values on the distressed, illiquid assets the government hopes to acquire. In buying them via reverse auctions, the government will make a market that creates fair value again, he suggested.

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Bernanke said that there are two prices at play: the current, fire-sale price of the assets which nobody wants to buy, and the “hold to maturity” price that the assets will eventually be worth when the income is finally received. The very low fire-sale price required by accounting rules is “not unreasonable,” he said, because the lack of liquidity of those assets right now.

“Because of the complexity of these securities and the serious uncertainties about the economy and the housing market, there is no active market for many of these securities. And thus, today, the fire sale price may be much less than the hold-to-maturity price. This creates something of a vicious circle,” he said. Fire sales spawn big writedowns and capital reductions, which, in turn, force additional sales, sending the price down further.

“One suggestion that has been made is to suspend mark-to-market accounting, and use banks’ estimate of hold-to-maturity prices,” Bernanke said. “Many banks support this. But doing this would only hurt investor confidence, because nobody knows what the true hold-to-maturity price is,” he added.

The price that the government pays would give banks a new basis for valuing such assets so that they do not have to use the “fire sale” prices, Bernanke asserted. The plan is intended to give better information on the value of assets and bring liquidity back to the markets.

“Let me come to the critical point: I believe that under the Treasury program, auctions and other mechanisms could be devised that will give the market good information on what the hold-to-maturity price is for a large class of mortgage-related assets,” Bernanke said. “If the Treasury bids for and then buys assets at a price close to the hold-to-maturity price, there will be substantial benefits.”

Bernanke’s comments were the first indications of what the government would be we willing to pay for mortgage-related assets. Senators questioned the Fed chairman along with Paulson and Christopher Cox, the chairman of the Securities and Exchange Commission, on how government would be able to determine a fair price.

“I’m not sure that the government can accurately emulate the market,” said Sen. Mike Enzi, a Republican from Wyoming.

Paulson acknowledged the challenge and said that groups of experts would be needed to evaluate the different asset classes. He said that although he is no fan of meddling with the market, he saw “no way to stabilize without government intervention.” Bernanke explained the process of the sale of up to $700 billion in assets as a “reverse auction” in which holders of illiquid securities would bid to sell them.

For his part, Cox said that the Financial Accounting Standards Board and the International Accounting Standards Board were working together to address how to deal with fair-value accounting. Cox noted that today FASB was holding a previously scheduled meeting of its valuation resource group. The group meets regularly to discuss how to improve valuation measurements and is considering amendments to FAS 157, the accounting rule that governs them.

Fair-value accounting has also come under fire from industry groups such as the American Bankers Association and the Financial Services Roundtable, which are seeking suspension of the rule. Jon Snowling, an ABA spokesman, told CFO.com that the group is seeking to have a meeting with the SEC as early as this week to discuss changes to fair-value accounting. The group has blamed the rule for sending asset prices on a “never-ending downward spiral.”