Thursday, May 27, 2010


Some of you might recall that back in October of 2009 I wrote "You Can't Turn a Pinto Into a Mustang." At the time I was using Ford cars to explain how - in the real world - you can't take a piece of crap car (Pinto) and suddenly revalue it and get classic car (Mustang) prices. That is, of course, unless you're one of the financial institutions that can take advantage of a Jan. 1, 2009 government ruling which says "Go ahead, revalue the toxic crap you own ... we don't mind."

In my October post I explained (by using Ford cars as a metaphor) how the Financial Accounting Standards Board's (FASB) 2009 ruling effectively allows America's financial institutions to ...

Level I: Price their financial instruments according to everyday market prices, known as the "mark-to-market" method.

Level II: Price their financial instruments according to what similar assets might sell for if more of them were around and/or sold. On this, think assessed value on hard to value antiques or one of a kind goods.

Level III: Ignore Level I and Level II pricing methods and simply make shit up ... known in the accounting world as the "mark-to-make-believe" method. 

All too often, it appears that America's financial institutions are using Level III mark-to-make-believe methods to make up their prices. What I didn't explain at the time are the details behind the game. Here's how it's happening ...

It turns out that when FASB implemented "Statement 157" on January 1, 2009 - in addition to directing financial firms on how to assess "fair value" for their goods (Levels I, II, or III) - it also left a loophole wide enough for William "The Refrigerator" Perry to walk through.

More specifically, FASB rules allow America's financial institutions to ask for a pricing waiver on financial instruments if they don't like the numbers from Level I or Level II methods. This is akin to a homeowner who hopes to secure a loan on their house being able to say, "I don't like the value my house was assessed from the Level I or Level II methods. I want a waiver so I can apply mark-to-make-believe (Level III) methods ... yeah, I want to let Peter Rabbit assess the value of my house."

Put another way, you get another shot at reassessing the value of your house at a price that has nothing to do with what it's really worth. Making matters worse, other financial institutions, the American taxpayer Federal government, and other unsuspecting market players have to play along with the charade and accept the price too.

To be sure, the financial firms have to fill out some extra paper work to gain access to the mark-to-make-believe (Level III) pricing method. The FASB does have it's standards (wink, wink). But what's a few more fairy tales penned in an economy that already has an Alice in Wonderland character to it? Once you're down the rabbit hole does it really matter if you burrow deeper?

Gaining access to mark-to-make-believe (Level III) method is the result of a loophole that says if your financial asset is exposed to "forced liquidation or distress sale" conditions you can apply for a waiver. As you might guess, given the market conditions of the past year, virtually any toxic financial instrument created on Wall Street could qualify for a Level III categorization, as long as the financial firm is willing to do the paper work.

And just like that, a toxic CDO or an SIV (which are akin to financial toilets), can be revalued to some made up number that makes Wall Street's financial mandarins feel better about themselves. More importantly, because of Tim Geithner's hare-brained scheme - which allows financial firms to use their toxic crap as collateral for new money - financial firms can dump their repriced assets on the American taxpayer Federal Reserve for new loans, credit, and profits.

To be sure, the market value of the product may still be in the toilet. But who cares? As long as the book value of the instrument hasn't collapsed we can all make believe that our banks are doing just fine. Thank you FASB.

In the end, it's because of FASB (which is under the SEC) that Wall Street's biggest players (1) have been able to maintain the illusion that their assets and their financial institutions are worth more than they really are, and (2) can go to Uncle Sam for more loans and credit guarantees, using collateral that's toxic and/or has tanked in value.

So, yes, if you work in Wall Street's Alice in Wonderland world, it appears you can turn a Pinto into a Mustang.

-  Mark

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