April 18, 2009

Mark-to-Market or Mark-to-Myth?

Weekly Snapshot
• S&P500 closed at 869.60 - up 30% since the eerie low of 666.79 on March 6.
• GE's first-quarter earnings fell 36% but beats Wall street expectations
• Citigroup reported its smallest quarterly loss since 2007 - beats forecast
• Goldman Sachs reported a net profit of $1.8bn for the first quarter 2009
• JPMorgan Chase posted a net profit of $2.14bn for Q1-2009
• Wells Fargo expected to make a $3bn profit for Q1-2009
• UBS forecast a quarterly net loss of almost SFr2 bn ($1.8 bn)
• UBS expects to shed 8,700 jobs, about 11% of its workforce
• Mary Schapiro, the chairman of the SEC, called for an “intense review” of credit-rating agencies
• Consumer prices dropped by 0.4% in the year to March - first annual drop since 1955
• More than 800,000 foreclosure filings in US for the first quarter09

Recommended Read
Ten principles for a Black Swan-proof world: http://www.ft.com/cms/s/0/5d5aa24e-23a4-11de-996a-00144feabdc0.html

Nassim Nicholas Taleb offers a neat list of simple rules that could prevent another economic Black Swan. It's also a stark reminder of an urgent need for simplification instead of complexity. It's a call for smaller, more stable and more transparent institutions. These 10 simple rules are beautiful in their simplicity and yet powerful enough to actually work if adopted by our leaders. Why can't regulation be that simple and yet effective?

Mark-to-Market or Mark-to-Myth?
Several major US banks reported earnings above expectations this week. A miraculous recovery or yet another form of creative accounting?

Let's consider this: With regard to Wells Fargo, it may be a specific change of an accounting rule that significantly impacted the bank's earnings for the quarter.
As FT Alphaville reports in: http://ftalphaville.ft.com/blog/2009/04/14/54655/on-wells-fargo-and-banks-well-being/

"The jump in earnings pertain to FAS 160, an accounting rule first announced in 2007 that became effective on January 1, 2009. The rule addresses accounting for minority interests, and mandates that the ownership interests in subsidiaries held by parties other than the parent corporation be clearly identified and presented as equity for the purpose of consolidated reports. Until now, minority interests in the U.S. have been reported either as a liability or as a mezzanine line item between liability and equity.

The effect of the new accounting rule allows certain liabilities to ‘jump over’ to the asset book as non-cash transactions via paid-in capital, thereby rolling directly into earnings and boosting reported equity. In the case of Wells Fargo, the bank found itself with up to $824m it could use this quarter as an accounting gain to earnings."

This may explain certain specific improvements in Wells Fargo's case. How about the others? GE, Citigroup, Goldman Sachs and JPMorgan Chase all beat analysts expectations and caused quite a stir among analysts on Wall Street. In fact, the jury is still out trying to explain the speedy and almost miraculous recovery of the same banks that were said to be in intensive care just a few weeks ago.

Is it a coincidence that just recently, the Financial Accounting Standards Board ("FASB") issued the final version of fair valuation guidance that makes "pricing securities at market value optional"? The rule suspends the need for mark-to-market accounting if the holder of a security thought only a distressed “fire sale” price was available. As they say beauty, or in this case "value", is in the eye of the beholder - how nice and how gratifyingly convenient (for the Banks)... I sense another one of those "things that make you go hmmm".

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