|
|
MAKING CENTS OUT OF THE NEWS
Blog #16
(April 23rd, 2009)
A PARTIAL RETURN TO COMMON SENSE
By Tom McAllister, CFP™
The Financial Accounting Standards Board, responding to pressure from Capitol Hill lawmakers, finally returned to common sense territory relative to the valuation of illiquid mortgage assets. As readers of my blog will recall, I have repeatedly criticized the mark-to-market rule requiring banks to account for mortgage securities, along with credit card debts and student loans, based on "current market value". Banks have justifiably complained that mortgages are secured by viable real estate assets with strong cash flows meant for the long term, and that these mortgages should not be valued in the same manner as liquid assets. Even though today's credit crisis has eliminated ready markets for real estate-backed assets, investment in these assets was done with an eye towards the future
The new, more lenient standard apply to more than 90% of residential mortgages, many of which have been securitized into CMO's (Collateralized Mortgage Obligations) by investment banks. Auditors will have the power to use the new approach when there has been a "significant decline of a market for new issuances." FASB Chairman Robert Herz explained "there will no longer be the presumption that these assets are being sold in a distress sale."
A second provision approved by the Accounting Standards Board will allow companies to put illiquid debt assets (such as mortgage securities) into an accounting category called "other comprehensive income" rather than being forced to write these assets down based on today's values. If assets are "impaired", meaning companies no longer believe they can collect all the amounts due, companies will need to provide updated reports on these assets to justify the category "Other comprehensive income".
I welcome both these new guidelines as more realistic and appropriate as compared to mark-to-market accounting. Investors in financial stocks are still protected, in that outside auditors must approve the use of those guidelines prior to each financial institution's quarterly report.
The SEC is now considering another common sense measure - bringing back the "uptick" rule to stock trading. This rule was first put into place during the Great Depression to prevent traders from manipulating stock prices. Short sellers* borrow stock in the hope the price will fall, then they buy it at lower prices, give the new stock back to the lender, and pocket the profit. "Short selling" is a legitimate trading practice that was being abused. The uptick rule required that a stock's price be up at least one cent from the latest different prior price before that stock could be sold short. The rule was effective for many years in preventing manipulation of stock prices and in restoring market confidence.
Note: Short selling in the stock market is not related to what are called short sales in real estate, in which lenders accept less than the amount owed them when owners sell properties that would otherwise be subject to foreclosure.
Then, in the summer of 2007, right before the market peak, this sensible rule was repealed by the SEC. In the fall of 2008, the Commission partially reversed the damage done by temporarily suspending all short selling altogether in some 800 stocks. I, along with other market observers, have been urging that the uptick rule be reinstated. The SEC is now considering bringing back the rule and instituting other restrictions on short sales. If it does not, then Congress should. Reinstating the uptick rule will help balance out the market.
My slogan from an earlier blog post bears repeating: "Mark to the Market is Dead! Long Live the Uptick!
With all the rapid changes in our economy and in the investment markets, there are many investors who would benefit from more consistent guidance. We are currently accepting new financial planning and investment clients, and would appreciate your referrals.
|
| |
| |
______________________________________________
| |
Click To Print This BLOG
