SEC - and You Should Be Able to Find Out

Re SEC Report on Mark-to-Market Accounting

The SEC's Staff has released recommendations regarding fair-value accounting. The Executive Summary is worth reading in its entirety. The press release is a good quick read as well.

A top-down comment: probably all independent bloggers I have seen will breathe a sigh of relief that mark-to-market is supported. What happens to these recommendations, and what commentary and explication there are of the details, will be interesting to observe. The report makes explicit that SEC as a whole does not necessarily agree with this report.

For now, I will keep to big picture comments.

1. Level 3 assets are, to put it politely, BS. If a financial institution wants to be publicly owned and wants to have Level 3 assets, let it disclose them in detail. If competitors see what they have, let them be envious of the high quality of these assets! If a company doesn't want competitors or investors to see what's there, there should be two alternatives: go private, or don't have these "assets" in the first place (or sell them; or give them away to charity!)

2. Market valuation can be manipulated. Goldman and Morgan Stanley can do a trade or two between themselves of CMOs or whatever assets they want at prices that are really fictional. So this gets back to point 1 above. A systemically important public company has no business owning highly illiquid securities and if it wants to own this sort of asset, it should disclose it so regulators and the company's owners (i.e., shareholders) can perform independent assessments of value. "Trust me" financial institutions are now oxymorons.

3. Market values of illiquid assets can change rapidly and drastically. Consideration should be given to the proposition that depository institutions should not be owned by companies that own Level 3 assets, whatever their level of disclosure. (This would imply at least a partial repeal of the 1999 repeal of Glass-Steagall.) Bank runs can be caused by threatened failure of the holding company that owns a subsidiary that is a depository institution: no Northern Rocks wanted here.

4. Everything said above re Level 3 assets should be considered for Level 2 stuff as well. Unpriced securities that are "like" other, priced securities but are different are . . . well . . . different. Thus their prices may be . . . different!

5. Page 4 of the report states that "fair value accounting did not appear to play a meaningful role in bank failures occurring during 2008". So all the apologists for Bear, Lehman and others should . . . apologize.