VIDEO: Debating Mark-to-Market Accounting (Janet Tavakoli & Bill Isaac)
Bloomberg TV Oct. 1

Janet Tavakoli argues for mark-to-market accounting for toxic assets in trading books, other areas where it is currently required, and vehicles into which these assets have been or may be transferred.. Bill Isaac, former head of the FDIC and now with Legg Mason, argues against it. He seems unaware of the malicious mischief in recent years in structured products and plays right into the hands of those who woudl avoid regulation and cover up problems. Unfortunately, Congress was being counseled by thos who are against mark-to-market accounting.

JT Note: Warren Buffett advocates mark-to-market accounting for the bailout in an interview with Charlie Rose (and Warren Buffett) on October 1 and CNNmoney on October 2, 2008. He proposed another viable alternative to the Bills floating in Congress. He proposes to let private equity investors put up 20%. The U.S. Treasury will put up 80% with the following terms: it gets paid back first, receives interest on its investment, and gets a share of the profits. This is a way of ensuring market pricing and allowing the banks to delever while the Treasury (the only source of a large enough balance sheet) levers up with the protection of a 20% cushion and mark-to-market pricing.]

Among other reasons to urge mark-to-market accounting, there is a multiplier effect of losses (for some securitizations) because“total loss” tranches were transferred to other securitizations (especially synthetically), so that some CDOs and CDO-squareds are largely worthless. No one can tell which securitizations have this problem without analyzing each one. The Treasury will buy a pig in a poke. This is not a matter of opinion or “different views” it is a matter of fact.

I am all for buying time for a forced restructuring, but financial institutions need to mark their assets to get the market out of the deep freeze. These are not “fire sale” prices in many cases. Many CDOs deserve the low prices since they were partially constructed out of air. This uncertainty of what is nearly worthless and what has value has frozen the markets.

Treasury Secretary Henry Paulson was unsuccessful in his first attempt to grab absolute power (see section 8), so new bailout plans include “Andy Fastow (remember Enron?)” accounting, which effectively thwart oversight. A lot of work has been done in the past couple of days to give Congress a bad education. If Paulson is allowed to use “hold to maturity” pricing, excessively high prices can be paid, and assets that have permanent losses can be easily covered up—just as investment banks covered up their permanent losses on securitized assets for many quarters. In other words, if you do not use mark-to-market accounting, it is much easier to lie. Therefore I recommend that we make it more difficult for anyone to lie to American taxpayers, and say we should adopt mark-to-market accounting. If we absolutely had to sell, what would we get for our money? We have a right to know.

It is not in the interests of U.S. citizens and taxpayers to abandon mark-to-market accounting for a proposal in which taxpayer funds are being used. If we would have to sell the assets at a loss due to downward moves in market prices, we have a right to know that. If the assets have permanent losses so that even if we hold to maturity we would have losses, we have a right to know that too. At any given time, we have a right to know what our “investment” is worth (but I recommed this “investment” should not be made and we should pursue a better alternative). Congress seems to have decided that U.S. citizens cannot handle the truth.

The Act extends the SEC's authority to suspend mark-to-market accounting (FAS 157) when it is "in the public interest and protects investors." Do not expect a thaw in the market freeze. The Act buries problems and prolongs price uncertainty. This a huge mistake. FASB board members support mark-to-market accounting, especially in illiquid markets. The SEC should, too. This provision is ridiculous and seems meant to promote hold-to-maturity pricing for credit derivatives trading books and CDO portfolios. The danger is that Federal portfolio managers can claim they are making money on carry trades while the assets are declining in value due to defaults or permanent value destruction of collateral. This situation can continue for a long time to create the false appearance of profitability. In other words, U.S. taxpayers can be told they are making money on their $700 billion investment, when in reality they are losing money. I would rather know the market price, even if the news is bad news.

Janet Tavakoli is the president of Tavakoli Structured Finance, a Chicago-based firm that provides consulting to financial institutions and institutional investors. Ms. Tavakoli has more than 20 years of experience in senior investment banking positions, trading, structuring and marketing structured financial products. She is a former adjunct professor of derivatives at the University of Chicago's Graduate School of Business.

She is the author of: Credit Derivatives & Synthetic Structures (John Wiley & Sons, 1998, 2001) and Structured Finance & Collateralized Debt Obligations (John Wiley & Sons, September 2008).

Dear Mr. Buffett: What An Investor Learns 1,269 Miles From Wall Street will be released January 9, 2009 and is available for pre-order on Amazon.. Janet Tavakoli takes you into the world of Warren Buffett by way of the recent global credit and mortgage loan crisis. In correspondence and discussion with him over 3 years, they both saw the writing on the wall. Dear Mr. Buffett is a witty well-told account of how principle triumphs over greed and panic, and is a must-read for all those seeking the timeless wisdom that has beaten, and continues to beat, the market.

Clients of Tavakoli Structured Finance have the benefit of proprietary research, which is not available in any other paid or public forum. Clients also commission proprietary research and analysis.

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