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TranceAddict Investors Club @ Marketocracy (pg. 135)
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| Shakka |
Great editorial by Jim Chanos today. Hopefully you know who he is. If you don't, you should.
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We Need Honest Accounting
Relax regulatory capital rules if need be, but don't let banks hide the truth.
By JAMES S. CHANOS
Mark-to-market (MTM) accounting is under fierce attack by bank CEOs and others who are pressing Congress to suspend, if not repeal, the rules they blame for the current financial crisis. Yet their pleas to bubble-wrap financial statements run counter to increased calls for greater financial-market transparency and ongoing efforts to restore investor trust.
[Commentary] Getty Images
We have a sorry history of the banking industry driving statutory and regulatory changes. Now banks want accounting fixes to mask their recklessness. Meanwhile, there has been no acknowledgment of culpability in what top management in these financial institutions did -- despite warnings -- to help bring about the crisis. Theirs is a record of lax risk management, flawed models, reckless lending, and excessively leveraged investment strategies. In the worst instances, they acted with moral indifference, knowing that what they were doing was flawed, but still willing to pocket the fees and accompanying bonuses.
MTM accounting isn't perfect, but it does provide a compass for investors to figure out what an asset would be worth in today's market if it were sold in an orderly fashion to a willing buyer. Before MTM took effect, the Financial Accounting Standards Board (FASB) produced much evidence to show that valuing financial instruments and other difficult-to-price assets by "historical" costs, or "mark to management," was folly.
The rules now under attack are neither as significant nor as inflexible as critics charge. MTM is generally limited to investments held for trading purposes, and to certain derivatives. For many financial institutions, these investments represent a minority of their total investment portfolio. A recent study by Bloomberg columnist David Reilly of the 12 largest banks in the KBW Bank Index shows that only 29% of the $8.46 trillion in assets are at MTM prices. In General Electric's case, the portion is just 2%.
Why is that so? Most bank assets are in loans, which are held at their original cost using amortization rules, minus a reserve that banks must set aside as a safety cushion for potential future losses.
MTM rules also give banks a choice. MTM accounting is not required for securities held to maturity, but you need to demonstrate a "positive intent and ability" that you will do so. Further, an SEC 2008 report found that "over 90% of investments marked-to-market are valued based on observable inputs."
Financial institutions had no problem in using MTM to benefit from the drop in prices of their own notes and bonds, since the rule also applies to liabilities. And when the value of the securitized loans they held was soaring, they eagerly embraced MTM. Once committed to that accounting discipline, though, they were obligated to continue doing so for the duration of their holding of securities they've marked to market. And one wonders if they are as equally willing to forego MTM for valuing the same illiquid securities in client accounts for margin loans as they are for their proprietary trading accounts?
But these facts haven't stopped the charge forward on Capitol Hill. At a recent hearing, bankers said that MTM forced them to price securities well below their real valuation, making it difficult to purge toxic assets from their books at anything but fire-sale prices. They also justified their attack with claims that loans, mortgages and other securities are now safe or close to safe, ignoring mounting evidence that losses are growing across a greater swath of credit. This makes the timing of the anti-MTM lobbying appear even more suspect. And not all financial firms are calling for loosening MTM standards; Goldman Sachs and others who are standing firm on this issue should be applauded.
According to J.P. Morgan, approximately $450 billion of collateralized debt obligations (CDOs) of asset-backed securities were issued from late 2005 to mid-2007. Of that amount, roughly $305 billion is now in a formal state of default and $102 billion of this amount has already been liquidated. The latest monthly mortgage reports from investment banks are equally sobering. It is no surprise, then, that the largest underwriters of mortgages and CDOs have been decimated.
Commercial banking regulations generally do not require banks to sell assets to meet capital requirements just because market values decline. But if "impairment" charges under MTM do push banks below regulatory capital requirements and limit their ability to lend when they can't raise more capital, then the solution is to grant temporary regulatory capital "relief," which is itself an arbitrary number.
There is a connection between efforts over the past 12 years to reduce regulatory oversight, weaken capital requirements, and silence the financial detectives who uncovered such scandals as Lehman and Enron. The assault against MTM is just the latest chapter.
Instead of acknowledging mistakes, we are told this is a "once in 100 years" anomaly with the market not functioning correctly. It isn't lost on investors that the MTM criticisms come, too, as private equity firms must now report the value of their investments. The truth is the market is functioning correctly. It's just that MTM critics don't like the prices that investors are willing to pay.
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.
The FASB is also changing the criteria used to determine impairment, giving companies more flexibility to not recognize impairments if they don't have "the intent to sell." Banks will only need to state that they are more likely than not to be able to hold onto an underwater asset until its price "recovers." CFOs will also have a choice to divide impairments into "credit losses" and "other losses," which means fewer of these charges will be counted against income. If approved, companies could start this quarter to report net income that ignores sharp declines in securities they own. The FASB is taking comments until April 1, but its vote is a fait accompli.
Obfuscating sound accounting rules by gutting MTM rules will only further reduce investors' trust in the financial statements of all companies, causing private capital -- desperately needed in securities markets -- to become even scarcer. Worse, obfuscation will further erode confidence in the American economy, with dire consequences for the very financial institutions who are calling for MTM changes. If need be, temporarily relax the arbitrary levels of regulatory capital, rather than compromise the integrity of all financial statements.
Mr. Chanos is chairman of the Coalition of Private Investment Companies and founder and president of Kynikos Associates LP.
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| jerZ07002 |
| quote: | Originally posted by Capitalizt
Pigs get slaughtered. The market is overbought here. |
Pigs get fat, hogs get slaughtered. ;) |
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| sean5 |
| will people who don't "sell sell sell" be in the "house of pain" ??:conf: :conf: :conf: :nervous: |
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| Krypton |
| quote: | Originally posted by Capitalizt
As I type this, X is at $23.90..You're welcome for the tip krypt ;)
Take some more advice and sell now before it plummets back to $19. Bulls make money. Bears make money. Pigs get slaughtered. The market is overbought here. |
I'm now at a 20% unrealized gain. I am starting to doubt. China has plenty of steel production by itself and doesn't need to import. Congress is thinking about a carbon tax on the industry which gives Chinese steel mills an advantage. I don't like doubting and according to The New Buffetology, no one should doubt an investment, otherwise one should not be in the investment. It also says to stay away from commodity-based companies because competition is so fierce and price wars eat away at profit margins. I am putting in a stop limit order at $21.
EDIT: My broker wants to charge another $4.95 to sell when I already paid that to buy. So I'm not selling.
I am going to sell at $50. |
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| Joss Weatherby |
| quote: | Originally posted by Krypton
I'm now at a 20% unrealized gain. I am starting to doubt. China has plenty of steel production by itself and doesn't need to import. Congress is thinking about a carbon tax on the industry which gives Chinese steel mills an advantage. I don't like doubting and according to The New Buffetology, no one should doubt an investment, otherwise one should not be in the investment. It also says to stay away from commodity-based companies because competition is so fierce and price wars eat away at profit margins. I am putting in a stop limit order at $21.
EDIT: My broker wants to charge another $4.95 to sell when I already paid that to buy. So I'm not selling.
I am going to sell at $50. |
Protip... make sure it says stop limit, and not just limit... :p
Though that mistake ended up saving me some money today! :p |
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| Krypton |
| quote: | Originally posted by Joss Weatherby
Protip... make sure it says stop limit, and not just limit... :p
Though that mistake ended up saving me some money today! :p |
lol, I decided not to sell. Buying X below $20 is a good buy historically as X rarely ever drops below $20. I need to stop doubting myself. The numbers don't lie. |
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| Capitalizt |
| I think you'll have another shot at sub $20 krypt. Take profits when you can and consider rebuying and bargain hunting for other stuff when the S&P gets back down to 740-750. |
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| Krypton |
| quote: | Originally posted by Capitalizt
I think you'll have another shot at sub $20 krypt. Take profits when you can and consider rebuying and bargain hunting for other stuff when the S&P gets back down to 740-750. |
I have to resist the urge to trade. I have way too little money to trade, and if I trade now, capital gains and commissions will eat me alive. |
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| Capitalizt |
| Capital gains tax is only 15% now (I think).. If anything you should be trading now before the higher Obama rates kick in. Or open a Roth IRA and trade tax free. |
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| Krypton |
| quote: | Originally posted by Capitalizt
Capital gains tax is only 15% now (I think).. If anything you should be trading now before the higher Obama rates kick in. Or open a Roth IRA and trade tax free. |
X was an investment mistake. I overlooked the price competitiveness of the industry. I should only be buying companies with a durable competitive advantage. I am selling tomorrow morning with a stop order at $23.
In the meantime, I am eyeballing Coach Inc. They are financially great and seem to have this durable competitive advantage. Great brand name. Ability to raise prices on their products. Definitely not a price competitive industry as people want expensive handbags. |
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| sean5 |
| short term capital gains are taxed at ordinary rates up to 35%. you have to hold more than a year to get the favorable rates. dividends are taxed at 15%. |
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| jerZ07002 |
| quote: | Originally posted by Capitalizt
Capital gains tax is only 15% now (I think).. If anything you should be trading now before the higher Obama rates kick in. Or open a Roth IRA and trade tax free. |
If the cap gains rate goes up it likely will apply retroactively as to prevent such actions. |
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