By LLOYD TAYLOR

Trader Joseph Masters watches the boards on the floor of the the New York Stock Exchange last year. —Photo: AP
On April Fools Day 2009 the banks and financial institutions got a significant upward bounce in the value of their stocks.
This increase is a direct result of an accounting rule-change made by the Financial Accounting Standards Board (FASB) details of which can be viewed at http://www.fasb.org/pdf/fsp_fas157-4.pdf.
Im essence, it allows bankers to shift from entering the book value of their assets on the basis of market values—what is known as “…mark to market” to a method of entering the book values of their stocks based on bankers’ own reckoning of the book value of their assets based on prices in a normal market.
After two years of widely divergent volatility pointing mainly downwards, the FASB decision helped to sustain a stock rally among banks (BOA, Citi Group, Wells Fargo), commodities (oil futures, copper and wheat) on one day -April 1st. The day’s snapshot showed that the Dow industrial averages closed at 7,978.08, S&P 500 closed at 834.8 and NASDAQ at 1602 for respective increases of 2.79%, 2.87% and 3.3%.
The FASB ruling on close examination has left many questions unanswered. What factors would be used to ascertain fair market value of an asset when there is no market activity? How could we discern value without the prospect of gain or loss underscored by effective and active demand? How much quantitative decline from the last historical value will constitute a disorderly transaction? How would we get an orderly or any transaction when the market for an asset is inactive?
Two examples may highlight the confusions in the FASB’s text. Were I the owner of a piece of machinery that no one wants to buy, despite widespread public promotion that it exists for sale, I should assume that means that the market is inactive. I should enter the historical book value of the equipment, not one that is infinitesimally positive. By FASB’s reckoning, it is reasonable to presume that I can pawn the asset or borrow money against it because the book value determined on the basis of an orderly transaction, would make it bankable. We all know that it is insane, not just irrational, to expect a bank to lend money on that basis. If the rational thing to do is to dump the asset as garbage that has only salvage value, why then would an investment bank want to rig the value of toxic assets above what a mark to market valuation suggests it should bear?
Alternatively, assume the asset is a financial instrument such as a collateralized debt obligation (CDO), leveraged at $30 to $1 of real physical asset value. If the price falls to a ratio of $10 to $1 of physical asset value upon which it leveraged, it may be safe and sane to consider that I did not lose $20 of asset value. The significant reality is that I possess the asset, and can exercise the option prospectively to re-value the CDO at a price it would fetch in an orderly transaction.
The ruling comes dangerously close to saying that in financial asset valuation we should accept that an inactive market only means that buyers have postponed interest only temporarily, however indefinitely! And that the de-leveraging of the asset will have limited impact on value. Also that an orderly transaction takes place when I buy my brother’s worthless painting in cahoots for $200,000.00 and that the transaction not only sets the floor price for the new market value, but sustains it, however long the market stays inactive thereafter. The valuation rule change actually allows banks to value assets at values higher than what people are willing to pay for them. It is not significantly consequential that the rule must not be applied retroactively, and that any resulting change in asset valuation must be disclosed.
The issue of convenience is important because it is investment bankers world-wide who started the speculations in derivatives and other exotic financial instruments that crashed the global financial system. Those speculations went way beyond the role of banks to service the financial demands for physical economic growth. Speculation in collateralized financial instruments became an end in itself. The darkness at the center of financial thought was the idea that money made more money, not by expanding output to match demand in the physical economy for goods and services, but by piling collateralized debt obligations (CDO) one on top the other in an endless spiral of upward value that dwarfed to meaningless proportions the slice of the value of the pool of real asset lying at the base.
The risks were compounded by adding the credit default swap (CDS) to protect investors, in say, credit mortgage obligations and bonds from losses arising from default. In a swap contract, a buyer makes periodic premium payments to a seller. In the contract the reference insurer holds the debt and undertakes to pay it. If the insurer defaults on its debt obligations the investor is paid a one-off payment from the other counterparty to the contract. The CDS is then terminated. That is the wrecking ball that leveled Lehman Brothers, sank AIG and led to shockwaves on Wall Street. These hot financial instruments allow investors to place bets on the success or failure on just about any aspect of a selected entity’s economic fortunes. This is the definition of gambling.
Under conditions of regulation the insurance coverage of the risk of default of the CDS should be enough guarantee that losses from a default can be paid. Except that with no regulation in the CDS market, the grave consequence is there is no way of knowing that any buyer has the means to cover losses when the financial product defaults, as it is traded from investor to investor.
The erasure of mark to market valuation is designed to restore partially what are gamblers’ losses from bets in a legitimate, but immoral Ponzi-scheme containing investments in quadrillions of derivatives within America and European Union countries. The problem of determining the price of banks assets in abnormal market conditions was raised by James K Galbraith, economist and Professor of Government, University of Texas in a piece appropriately entitled: No Return To Normal. He argues thus: “The only price at which assets could be disposed of, protecting the tax-payer, was … the market price.” Adding that: “… In the collapse of the market for mortgaged-back securities and their associated credit default swaps, this price was too low to save the banks. But any higher price was too high, would have amounted to a gift of public funds, justifiable only if the assets might recover value when normal conditions return.”
The change from mark to market accounting valuation sought to address the bankers’ toxic asset dilemma. The alternative would be for the US Treasury Secretary to put the banks under bankruptcy proceedings, place the worthless assets in a special corporation and restore a healthier balance sheet to the banks. That is the procedure banks apply to failed businesses and households, almost without exception. In this economic climate banks have been thrice blessed. Their creation of the financial crisis has been rewarded with a $700 billion USD tax-payer bailout, the avoidance of bankruptcy proceedings, and now an accounting rule. Investment bankers on Wall Street now have the authority to restore book value of assets, without reference to market-based valuation of their assets in collateralized securities.
The accounting rule change forced the FASB into a compromising position. It included insistent complaints from banks that housing values plummeted as a result of distressed sales. There was pressure from congressional republicans and democrats for the FASB to act. Well the five members, previously resisting the appeals from banks to alter mark-to- market accounting valuation methodology, capitulated in what in retrospect would be seen as an historic volte-face for the guardians of accounting measuring standards in America.
One FASB member, Lawrence E. Smith, confirmed the difficulty an independent standards setting Board faces to not ignore the conditions of the operating economic environment. In response to investor criticism the FASB required banks to expand disclosure of the housing-based assets in question.
After the rule change, Edward Yingling, the President of the American Bankers Association praised the FASB. That compliment should surprise no one. The bankers want to have their cake and eat it. Among the world’s most powerful lobbies they make rules and break them as effortlessly as they bend most politicians to do their bidding.
The FSAB’s vote was condemned by the Investors Working Group led by two former SEC chairmen, William H. Donaldson and Arthur Levitt, Jr., as a distortion of reality. The IWG said that “ …FASB proposals will reduce the free-flow of reliable and transparent information, undermine investor interest and weaken their ability to make sound financial decisions.”
Here we see a predisposition of major economic players to insist on regulatory changes to ameliorate the impact on collateralized debt obligations of the 29 % fall in the market values of single- family homes. The rule change helps them to manage adverse price and valuation caused by supply and demand forces.
This is in sharp contrast to households. Unlike banks, the balance sheets of households enjoy no similar relief. The ruthless application of mark to market standards for measuring personal credit worthiness is the norm. Everywhere ordinary citizens still face the harsh reality of lower income, job losses, shrinking housing asset value, declining equity and rising household debt for mortgage, education and consumer loans. The sub-prime mortgage debacle that triggered, not caused, the financial crisis is used as the excuse to increase the points required for individuals to qualify for credit. It could be argued that the consequence is the adoption of a far too restrictive approach to evaluating credit worthiness that dampens aggregate demand and weighs down the economy further.
Banks and bankers have been at the cosmic eye of the storm that has sent the American economy and the economies of the world’s sovereign nations in a tail-spin. The rule change may suggest that they are willing to close their eyes to the reality of true market values.
It’s worth noting that the accounting rule change coincided with the staging of the G-20 Nations Summit in London, UK, this April 2009. Not only was the change widely expected, but the Financial Crisis Advisory Group - creature of the International Accounting Standards Board and FASB- wrote UK’s PM Gordon Brown to advise “…that the group was considering how improvements to financial reporting may enhance investor confidence in financial markets.” The Summit’s determination to regulate hedge funds and off-shore banks is still only expressions of good intent, if governments’ accommodation to an accounting valuation rule change to assess fair market value, is any measure of the capacity to resist the international banker’s lobby.
The reign of the international financial oligarchy’s influence continues undiminished, after hundreds of years and the world’s worst financial debacle in anyone’s living memory. Some professional guardians of social-science objectivity across disciplines and major political leaders seem ready to surrender their responsibility to civil society. With the financial crisis far from over, the world’s populations have an opportunity to change the balance of power between global corporate imperialism and national sovereignty. The outcome is still an unanswered question.



















