Banking Law

Adrienne Carter at Businessweek isn't happy about yesterday's revelations in The Wall Street Journal about the success of bank lobbyists in influencing Congress to pressure FASB to relax mark-to-market accounting rules for banks' so-called "troubled" assets, which FASB did in April. She cites a Felix Salmon article (which I'll discuss further) as painting "a pretty grim picture of what's happening in Washington." As for herself, Ms. Carter thinks the WSJ "missed the bigger picture," that being that the FASB change will derail the PPIP because banks will use "mark-to-model" accounting to "overvalue" assets on their books that they should be offloading through the PPIP at more depressed "mark-to-market" prices. She's wondering why the bank regulators aren't stepping in to force the banks to sell the distressed assets at mark-to-market prices.

Because, Adrienne, the entire purpose of the PPIP was to attempt to establish a market price for the assets and to avoid those types of losses, because banks were screaming that the prices were temporarily impaired by unprecedented market conditions, and that the banks would be forced to take an unjustified hit to capital if they were forced to sell them (or to value them while they held them) at what the banks allege are "fire sale prices." In theory, PPIP was supposed to encourage banks to sell at, and buyers to pay, higher prices by providing favorable government financing. The PPIP was supposed to create a higher "market price" and to spur sales at the same time. There's no question that the accounting rule change has now impaired the PPIP's likely success, but I never thought it had much of a chance of success to begin with because I saw no reason for the banks to take any substantial hits to capital. PPIP just didn't seem likely to establish high enough "market" prices to justify the substantial capital hits that would be required. The market "sucks," even with the government-provided cheap financing, and I never saw buyers becoming insane and suddenly offering high enough prices to make the haircuts tolerable.

Adrienne's correct in assuming that it would take a regulatory mandate (official or unofficial) that forced banks to sell to overcome that resistance. However, that's not going to happen because that may very well lead to capital impairment and more bank failures. If the Treasury wanted to get the "troubled" securities and loans off the banks' balance sheets, then it should have done what was first proposed by Bernanke and Paulson way back when: have the government buy the assets at "held-to-maturity" values and have the government hold them until prices returned. It soon became clear that there was no political will to follow through on that plan, which would have transferred the risk entirely to the federal government. Since then, all the federal government has done is gum up the works to no useful purpose.

As for Felix Salmon, he's a man after my own heart, even if he's spitting into the wind. He thinks the entire mark-to-market controversy could have been avoided if the bank regulators had just (as a West Virginia female friend of mine is fond of saying) "grown a pair."

My feeling is that the problem wasn?t the mark-to-market accounting rules, so much as the sense in government that decisions about recapitalization, nationalization, and other forms of regulatory intervention must all be made based on FASB principles and US GAAP. If we had grown-up regulators who understood the concept of regulatory forbearance when you?re in the middle of a hurricane, there wouldn?t be any need to fiddle the books in this manner ? and, for that matter, there wouldn?t have been the horrible shuttering of WaMu, either.

The whole episode is just as tawdry as the WSJ paints it to be, and is ultimately based on the weird idea that FASB rules accurately reflect reality, and that therefore if we change the rules, we must be changing the underlying reality as well. Welcome to Washington, I guess.

"Regulatory Forbearance." Now, that's a term that's been a curse word in D.C. since the late 1980s. Congress tried that with the Competitive Equality Banking Act of 1987. Less than a year later, the handful of thrifts who were operating under forbearance plans that were permitted by that law, and that were approved by federal regulators, had them yanked out from under them when Senator William Proxmire denounced them on the Senate floor and the federal regulators cravenly hastened to find that each such thrift had suddenly failed to comply with its individual plan. When the federal regulators granted "regulatory forbearance" to acquirers in the case of insolvent thrift resolutions that used "supervisory goodwill," in connection with the Southwest Plan and other thrift rescue schemes of the 1980s, and in connection with "open bank" assistance transactions, Congress rescinded those forbearances (in effect) with the Financial Institutions Reform, Recovery and Enforcement Act of 1989. More recently, we've seen how TARP was torpedoed by Congress changing the rules of the game after the game had already begun.

No, Felix, no regulator, whether grown-up or puerile, is going to grant forbearance to any bank unless it is too big to fail, and even then, they'll extract a pound of flesh in return. As for GAAP, federal law was changed in 1989 to require regulatory accounting principles to follow GAAP. Moreover, unless a bank is out of any other options, they'd be foolish to rely on any forbearance that the regulators might grant. The government has demonstrated time and again that its word is worthless.

Salmon's contempt for a slavish devotion to GAAP is well put, however. One of my mentors earlier in my legal career, at a time when banks were going through another rough period and when bankers thought that the term "regulatory accounting forbearance" actually meant something concrete, used to  wonder how people who were mark-to-market devotees lived on a day-to-day basis. Why didn't they simply spiral down into terminal depression each day the market dropped and rocket up into an orgasmic ecstasy each day the market rose? I mean, if mark-to-market is reality, then reality can bite or be pure bliss, and all in the same day, can't it? Is that how we want to live? Is that how we want invest and plan for the long term? I'm not against FASB or mark-to-market principles as a general proposition. I'm simply against falling in love with any accounting concept or principle and treating it like it's sacrosanct no matter what the circumstances and no matter what the effect. That's called "fanaticism."

One other thing: Does it seem to anyone else that much of the commentary we see on the current banking crisis appears to be written by folks who think that the world began ten or fifteen years ago? Perhaps, it's just me.