Thursday, May 27, 2010

Feeling Their Pain

Today is Thursday, 27 May 2010.

Under rules proposed by the Financial Accounting Standards Board, banks and other lenders would be required to value the loans on their books at “mark-to-market”. That is, each day, they would be required to value the loans at the prices the loans would have commanded in the marketplace that day. (This is already required for stocks and bonds, including many mortgage-based bonds.) Sounds like a proper reflection of the normal operating of the much bally-hooed “free market” and its “imaginary hand”, oui?

Not according to many lenders, who’ve been allowed to value their loans based on their own private projections of prices the loans might command at some point in a sun-drenched future (rather than at the in-the-crapper prices some often bring). (Lenders call such prices "fair value".) In other words, the executives at the lenders orchestrate the guessing of prices, which just happen to make their balance sheets look the most impressive, and then demand commensurate pay. Pay for possible performance.

A modest example, by way of comparison. I’m currently editing a collection of my plays. I firmly and sincerely expect that, when published, it will rocket to the top of the bestseller lists, and sell at least a million copies at $29.95 each. (And I’m not including translation rights, movie rights, graphic novel versions, the McHH Big 900Gram Burger, T-shirts and coffee mugs, etc.) Therefore, my personal balance sheet shows a current net worth of $29 million, before taxes. Without quibble, any lender in their right mind would salivate at the opportunity to lend me $5 million tomorrow, knowing there’s zero chance I won’t repay. Oui?

So, I’ve developed a win-win solution. Each lender will be required to report two sets of figures. The rule for Set A: all loans will be valued at the price determined in the market at the end of each business day. The rule for Set B: all loans will be valued at any damn number the lender claims to have produced from any damn hat, implicitly presuming that everything were always to come up roses in this, the best of all possible worlds.

The latter will be styled, “The Subjunctive Rule”, and may be referred to in the industry as “The Sandy Rule”, after my most-esteemed high school English teacher. (The French are demanding the nickname be “The Sandy-Candide Rule”, to honour Voltaire also. I’ll ask Sandy if she can live with it.)

Perhaps the most fundamental objection that many lenders have is that, in the case of assets they intend (for now, so they say, and with no penalty if they change their minds) to hold long-term, mark-to-market results in recognition of immediate losses which may or may not actually occur in the future, and thus reduces short-term earnings (and thus, hopefully, executive compensation). Were this objection to be recognized as valid, it follows, as the night the day, that stocks and bonds should also be valued at the prices that financial institutions believe (or claim to believe) were to occur in the future, in this best of all possible worlds.

There’s a reason that I called going to work on Wall Street “Walking Through the Looking Glass”.

Keen readers may recall that I've previously addressed this subject on 31 March 2009.


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