October 13, 2008
Ladies and Gentlemen:
In connection with your review of the Mark to Market accounting rules I would offer the following observations as both a CPA and Individual Investor. What I propose is actually a relatively simple solution, which addresses the issues and difficulties that have rocked the individual and commercial mortgage markets.
Statement of Problem:
While I agree that having an independent measure of the value of any security the Mark to Market accounting rules are far more applicable to Investments that are both completely void of control by either the buyer or the issuer. The current rule seems to lose sight of the inherent differences between investment securities.
Statement of Difference:
Stocks have no reasonably measurable value beyond what they can be traded for in the market since the underlying issuer can not, in any reasonable period of time impart ongoing value to there traded shares other than to liquidate its company and distribute the proceeds to its owners. In these cases the only reasonable approximation of values is the Market Price.
With respect to Mortgage backed securities the determination of Value has a very different component to it that appears to have slipped past the most studious of accountants. That is the fact that the REAL underlying issuer of the Mortgage (or lease) is the owner of the underlying property. Current rules ignore the fact that the Mortgagee or Lessee is the only person or entity with actual knowledge of their situation and it is their ability and willingness to meet their obligations, which the vast majority do. Thus they impart ongoing value to the ultimate holder of their mortgage
Statement of Objective:
I would strongly argue that the holder of Mortgage Securities should be allowed to value them on a basis that provides recognition that there is some degree of certainty in a cash flow stream with an implicit interest rate attached to it. It should also recognize that, absent an orderly market for such securities, the lack of immediate liquidity should also be accounted for.
For mortgages or long term commercial leases where there has not been any delinquency or event of default its value should be equal to 96% of the present value discount of the underlying payment stream. The 4% discount is enough to account for the costs of administration of the mortgages and transfers, particularly on a portfolio basis. This fully recognizes both the ability and willingness of the actual issuer (Mortgagee) to influence the value of the security they are responsible for.
For Mortgage Securities valued thusly, lack of liquidity recognition can be given by requiring balance sheet presentation as a Long Term Asset, with amounts due within 12 months presented as Current Assets.
To the extent that rates drop and the market for mortgage backed securities allows for a premium there should be no allowance for balance presentation in excess of the 96% P.V. Rather, such gains should only be recognized when realized. However when such a premium is readily obtainable and the securities trade above "par" then the underlying Securities should be allowed on the Balance Sheet as Current Assets.
To the extent that the underlying mortgage has been delinquent or in default in the past the payment stream can not be reasonably assured and therefore must be value at its Net Realizable Value.
Thank you for taking my views into consideration in undertaking your duties with regard to this study.