November 17, 2008
Members of the Panel,
Sometimes a complex matter such as this is best viewed through the eyes of an example.
A banker wishes to make a mortgage loan to a credit worthy customer. That person has a very good but not excellent credit rating, has a stable job which will allow them to readily make the necessary payments, and has 30% of the value of the intended home purchase in available cash, of which 20% will be used for a down payment. Finally, the agreed upon home is fairly priced given the current market condition.
As this appears to be a creditworthy customer who is financially sound, the banker wishes to make the loan but does not.
The banker is required to use fair value accounting to account for this loan. Unfortunately - even though the bank intends to hold the loan until maturity or payoff - the bank would also have to immediately discount the carrying value of the loan from its face amount. As this would negatively effect the banks capitalization ratios, they must decline the loan.
This bank has been forced out of its role as community lender, and will now invest primarily in U.S. Treasuries.
Although this example is admittedly a simplification of a complex process, it demonstrates how fair value accounting can strangle the flow of capital necessary for a healthy economy.
In my opinion to repair this flow of capital a loan made by a financial institution of any kind should always be valued at its face amount unless it meets established default criteria. At that point and ONLY at that point (which realistically can be easily measured and identified) should fair value principals then be applied to the carrying value of this loan on the banks financial statements.
An excellent example of how this would be applied can been seen with the recent effort by certain high profile financial institutions to avoid foreclosing. They have offered to periodically review the income position of the homeowner, and reduce the interest rate for that period to 30-35% of that owner's annual income an amount that allows them to service the loan.
The application of fair value accounting would require that the loan be adjusted to some market value, or perhaps the net present value of the expected future cash flows. Yet, one can argue that if the homeowner accepts this offer, they are highly unlikely to ever walk away given the difficulty of replacing their home for the next 7-10 years - especially given the willingness of the bank to lower their payments yet again if they temporarily lose their job or otherwise. As the income level of the owner rises, the bank will eventually restore the loan to full service. Thus, this loan is very likely to pay off completely as the years pass.
The banks that are willing to do this should and will take an income statement hit each year they hold these loans, but as a matter of good public policy they should not be required to take a balance sheet one as well. Their vision is long term, not short, and they are doing a service not just to themselves, but to the communities they serve, and the nation as a whole.
Your time and attention to my input is greatly appreciated. Please choose wisely, the health of the U.S. economy is in your hands.
Douglas Levin, CPA, MBT
Levin Hu, LLP
Certified Public Accountants
77 Ho'okele, Suite 302
Kahului, HI 96732