Accounting Observer > Public Blog - Defending MTM Accounting

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Defending MTM Accounting

Mar 24

Written by: Jack Ciesielski
3/24/2009 8:02 AM

After weeks of handing over the microphone to anyone who wants to bash mark-to-market accounting on its op-ed page, the Wall Street Journal decides a little equal time is in order. They handed over the mike to Mr. James Chanos, who provided an excellent analysis of the problems facing investors and the FASB at this pivotal moment in its history. From the editorial:

"The FASB and Securities and Exchange Commission (SEC) must stand firm in their respective efforts to ensure that investors get a true sense of the losses facing banks and investment firms. To be sure, we should work to make MTM accounting more precise, following, for example, the counsel of the President's Working Group on Financial Markets and the SEC's December 2008 recommendations for achieving greater clarity in valuation approaches.

Unfortunately, the FASB proposal on March 16 represents capitulation. It calls for "significant judgment" by banks in determining if a market or an asset is "inactive" and if a transaction is "distressed." This would give banks more discretion to throw out "quotes" and use valuation alternatives, including cash-flow estimates, to determine value in illiquid markets. In other words, it allows banks to substitute their own wishful-thinking judgments of value for market prices."

He's hit the nail on the head, I believe. While FASB is being yoked by Congress to "do something about mark-to-market accounting" before legislators do, they don't have to do harm. They could "do something" by sharpening disclosures for investors, for one thing.

The stability of financial institutions' capital can be extremely dependent on the very same securities they'll now have much more leeway in valuing. I've prepared an analysis of the twin proposals for clients in an Analyst's Accounting Observer report - and I've shown this dependency in it. Given that these proposals will affect regulatory capital, I don't think that diddling with the figures investors use is the right way for regulators to handle their responsibility for setting capital limits. Chanos is dead right in his suggestion that regulators "temporarily relax the arbitrary levels of regulatory capital, rather than compromise the integrity of all financial statements."

I don't do this routinely, but this is a momentous time for investors. From now until the end of the comment period (April 1), I'll send you the report if you send me an email. And I urge you to comment on the proposals to the FASB, even if it's just a brief email.

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Pension & Other Benefit Plans: A Look Ahead

Investors in firms with defined benefit pension plans always face the risk of suddenly being pushed farther back in line when it comes to being served their returns. Variability in plan assets and variability in benefit plan obligations are the reason: poor asset returns coupled with sinking interest rates always spell tough times for defined benefit plan funding. In that regard, this year’s asset returns combined with the Fed’s “Operation Twist” add up to “Operation Agony” for defined benefit pension plans. If trends continue along their current path, firms that may have anticipated moving to more realistic pension accounting - like Honeywell, AT&T and Verizon already have done - might forego that decision. It could be just too painful.

Pensions aren’t the only kind of benefit plan affected by Operation Twist. Other postemployment benefit (OPEB) plans share much the same accounting model as pensions, including the calculation of a projected benefit obligation that similarly incorporates a discount rate - one that will also be affected by Operation Twist. The net OPEB obligations were slightly less than pension obligations at the end of 2010, but also promise to grow in 2011. Investors perceive them as less threatening than pension obligations because they don’t require funding. Strangely, there are a number of firms that are recognizing income from these benefit plans - without ever creating a dime of cash for investors.

A recent edition of The Analyst’s Accounting Observer dissects these issues, and is available only to paid subscribers. A condensed version is available for free upon request. To receive it, send an e-mail to Brenda Rappold at brappold@accountingobserver.com, with “PENSIONS” in the subject line.

For information about subscribing to The Analyst’s Accounting Observer, click here.