(Original) This is NOT what I am saying, but this is essentially the bankers and their friends in congress are saying these days. Tomorrow FASB will vote on fasb 157 E. Note the (in)famous House Financial Service Committee (headed by Mr. Barney Frank, the same committee grilled Mr. Liddy on AIG bonus) had a hearing on “Mark to Market” accounting rule a few weeks ago. In the hearing some lawmakers pushed for changes.
The fat cats in Wall Street has enjoyed the upside of the “Mark to Market” (M2M) rule in past few years, collecting billions of dollars when the time was good. Now they are saying this M2M rule is unfairly reflecting the value of bad loans, hurting the capital of banks, and thus hurting the economy. Why did not we hear all these arguments when they were collecting all the money? Essentially they are saying they like the excitement of ONS, but they don’t like (getting) AIDs? Why don’t they stay away from ONS at the first place?
No Easy Answers, WSJ, 30Mar09
PAUL GIGOT: Steve, you’ve argued that fair-value, or mark-to-market, accounting is a major culprit in the financial meltdown. Why do you think that is the case?
STEPHEN A. SCHWARZMAN: I think there are a lot of complex reasons for this crisis, one of which I believe is the accounting system that we use that’s exacerbating the crisis and forcing companies, and particularly financial institutions, to mark down certain securities in markets that are not very liquid in sort of very large hits.
This has destroyed capital, that then makes it impossible for the institutions to lend money, and it also creates a problem of confidence in the system.
So, it’s pretty clear to me that for the good of the system you cannot allow that mark to occur the way it is. Imagine trying to run a bank. If you make a loan in the old world, the way a lot of us grew up, and you didn’t think it was impaired, you kept it on your books at par. Now, if loans are trading at $70, you make that loan, you lose $30 just for making the loan. Well, what would any rational person do? They would not make a loan, and you can’t blame them.
And so, even though there is a lot to be said for complete mark-to-market in a system that can take it, I don’t believe that the financial system, as currently organized with its current rules, can really take the full hit of it.
MR. GIGOT: If one of the problems, though, in the current moment is that nobody trusts the books, how does waiving the rules in the middle of a crisis get people to trust the books?
MR. SCHWARZMAN: With the current system, nobody believes the number [that financial institutions use for the fair-market value of the holdings on their books]. So, my argument would be that the current system clearly doesn’t work since nobody believes the number, that this must not be the right way to go because it clearly doesn’t work.
JAMES S. CHANOS: I have a few minor disagreements. I’ll start with my own anecdote, and that is when Lehman Brothers collapsed, we had an auction in their credit-default swaps to see where the writers of those insurance policies would have to pay out, and it turns out they had to pay out 91 cents on the dollar. And that equates roughly, right now, I think Lehman’s funded debt is trading somewhere around 15 cents on the dollar after a rally recently.
To give you an idea of what that means, Lehman had about $150 billion that those CDS contracts covered, their notes and bonds, but not their bank debt, of course, or their repo. There was also about $25 billion of equity, roughly, in common and preferred at Lehman, which we would therefore value at zero.
So what that tells us, back of the envelope, in somewhat anecdotal form, is that the hole in the Lehman Brothers balance sheet, give or take today and back in October, is about $150 billion. To put that in perspective, the hole in Enron, when the dust settled, when all the claims were paid, was about $60 billion or $70 billion. So, Lehman is more than twice Enron on a current-snapshot basis.
Now, we can talk about a billion here, a billion there and being off a little bit on what we’re supposed to be doing, but I would pose to you that right now the surprises have been and will continue to be on the downside where management has the latitude to mark this stuff. And I think a central tenet of what you’re saying is that you believe that a lot of this stuff is undervalued on bank balance sheets.
MR. SCHWARZMAN: I believe a lot of this stuff is impossible to know what it’s really worth.
MR. CHANOS: We’re looking at this through the wrong end of the telescope. Don’t disabuse the notions of fair-value accounting and better transparency in the interests of regulatory relief, particularly if it’s countercyclical. Simply grant them regulatory relief. We can grant regulatory relief on a temporary basis without compromising the integrity of the financial statements of all financial institutions.
MR. GIGOT: Bob, you want to get in on this?
ROBERT J. SHILLER: The first thing is to make sure that we preserve the integrity of our accounting. People know that this country stands for high integrity, and so anything that looks like we’re allowing people to doctor the books, I think we shouldn’t do that.
We should keep mark-to-market accounting, and we should work toward a countercyclical capital-standards system that gives relief, and it should be automatic at times of crisis like this.
MR. GIGOT: Could Congress or the Financial Accounting Standards Board do something to ease the current problem by easing mark-to-market requirements?
MR. SHILLER: That’s analogous to taking back the AIG bonuses. It’s something that people all over the world will notice and think that we’re losing our integrity. I just don’t think we can go that way.
The Roof Caves In
MR. GIGOT: Bob, since you have an expertise about many things but in particular housing, can you talk a little bit about whether the foreclosure mitigation that the administration is proposing is going to make a difference and is a good idea.
MR. SHILLER: I’m very glad that the administration is doing this, because I think it’s the core problem that hasn’t been addressed. But I would say that the more fundamental problem which should be addressed in the longer run is that we have a system that encourages homeowners to take leveraged, risky positions with all of their wealth in real estate in one city. And it kind of amazes me to look back and try to put myself in the mind-set of a couple of years ago.
Why were we telling people to do that? And now, according to Economy.com, we have more than 12 million homeowners who are underwater, and for a good share of them, that’s all they have. They’ve been wiped out, and yet they were following the advice of — it’s hard to believe how we could think that. I have a proposal that we should change our mortgage institution so that it helps the people. We should have a mortgage that includes, tacked onto it, some kind of home-equity insurance so that they don’t get wiped out. And people used to tell me, you don’t need that, because people are already in the optimal position in their portfolio, and I couldn’t understand. How can it be optimal if you have all of your life savings in this one leveraged investment? And now we know it wasn’t optimal.
MR. GIGOT: Isn’t the danger, though, with foreclosure mitigation, that you will prevent the natural bottoming of home prices? As hard as it is on some people, for the larger society, the faster you find a bottom, the sooner we can write off the losses and then start anew.
MR. SHILLER: I would like foreclosure mitigation to have the same form that it did in the Roosevelt administration. What the Roosevelt administration did when it created the Home Owner’s Loan Corp. in 1933 is it instituted the long-term mortgage. Back then, the problem was that you had to roll your mortgage every three to five years. And so they created a whole change in standards.
That’s what I would like to see now happen. I wish the president’s program had gone beyond a bailout into something more inspiring, that we are going to fix the system.
The Purse Strings
MR. GIGOT: Let me raise another issue which is much in the news, and that is this question of just how much the federal government can spend, borrow, guarantee, before the rest of the world decides that it may pull our credit card, and whether or not there are limits to the national balance sheet. We saw yesterday the latest proposal from the Chinese that they think the dollar has seen its final days as a reserve currency, and they want a replacement.
MR. SCHWARZMAN: I think the Chinese have been pretty open, that they’ve had people speaking who are concerned just about the concentration of the consumer economy and magnitude of deficits and wanting to, over time, rebalance their liquid exposure to the dollar. They’ve made it very clear that they don’t want to do anything over the short term that would destabilize the current situation further, and that’s a very, very important thing to them.
But somewhere between the short and the long term, they’ve said quite publicly they’d like to have less exposure to the dollar unless we change the character of our economy, which I assume to mean have more savings, less deficits and normal, sound economic planning. I don’t think there’s more to it than that.
MR. CHANOS: I’m not an international-finance expert, but looking at it domestically through the prism of a money manager, I would simply say that it seems to me that the only way in which we’re moving capital forward is with some sort of government assistance or guarantee. If it has that, it works. If it doesn’t, it doesn’t.
And the private markets are still leery, whether it’s due to accounting reasons or broader economic reasons, whatever they are, of dealing on its own without government assistance, and that’s kind of a scary situation over the intermediate and long term because what happens when government inevitably has to pull back from some of those measures, whether voluntarily or involuntarily?
The only other thing I would say is I thought that the pronouncement by the Chinese Sunday night was — they rarely are that direct. I mean, that’s like taking out a billboard in Times Square and saying, get your house in order; we don’t want to hold all your debt.
MR. GIGOT: Are there limits to what we can borrow and maintain our standing as a reserve-currency country?
MR. SHILLER: Well, unfortunately we have some difficult choices now because I think we need a stimulus package, and we all agree on that and we have to move forward with that, but the issues that you raise are important as well. This country has a reputation that’s extremely valuable. There is a trust in our debt, and unfortunately this situation we’re in is starting to shake it. And people are rational to have that worry.
I just want to remind you that the U.S. government has defaulted on its debt; I believe the last time was in 1933. They didn’t count it as a default. When Roosevelt came in, the first thing he did was go off the gold standard, and at that time U.S. debt had gold clauses which promised to pay in gold, and kind of unilaterally he just did it.
And so that is a default. That really was. And it happened in times similar to what we’re going through now. Somehow we’ve survived. Our reputation remains reasonably good.
MR. GIGOT: Are you saying you want to repeat that experience?
MR. SHILLER: Unfortunately that’s what people are worrying about now, and as I say, we have difficult choices. We don’t want to default on the government debt. We want to stay as far away from reminding people. But this is the dilemma. There’s no easy answer, that as the national debt goes up there’s going to be more and more memories coming up of this kind of possibility, or of the possibility of a major inflation that is deliberately wiping out the debt.