October 28, 2008
Trusted Capital Solutions, LLC
385 Whitcomb Blvd., Tarpon Springs, Florida 34689
727-485-6103 727-722-0610(fax) firstname.lastname@example.org
October 28, 2008
SEC Chief Accountant
It is unfortunate to see the FASB take up a position that lends itself to the benefit of those who are not too pleased with the standing of the USA as the nation with the most viable and diverse financial institutions base in the world. IN the US, we have in fact over 20,000 different financial institutions (Credit Unions, Insurance Companies, Banks, Thrifts, Commercial lenders (CIT, GE) and Hedge funds).
In many countries there are less financial institutions in those nations than can sometimes be found in a one mile stretch of road on a typical main street in an average American city. For those who prefer to financially engineer high interest rate returns by the use of monopoly positions, the actions of the FASB with FAS157 and then the dance with FAS140 and unreasonable reflections on the REMIC issues that never came up during the SL crisis when loans were being restructured, but during this crisis came along at a strategic moment during the first major burp caused by the Bear Stearns mortgage pool collapses of May/June 2007, are most fortunate. The rest of us ask why now, although there are many who would suggest this is how things must be...
The Basel 2 issues that have kicked in around the world have some basis in need as the different accounting and regulation structures that exist in the over 200 government regimes that are the focus of the financial world have gone from creating opportunities to
build specialized and profitable trade schemes, to a place where the vanilla box finish has to gloss over localized problems with the use of primer.
There is no question that as the information era has created an opportunity to break barriers which allow efficient use of capital, those who have been in positions to read the Federal Register on a daily basis and take advantage of its wondrous and vast specialized pieces of valuable information, have been over run by the Viking style tidal wave of new competition and unassimilated capital pools.
During this period of transition, there have been those 1000 critical capital institutions that have found themselves historically able to take advantage of the goodwill of the holy trinity of credit rating agencies, who have dominated access to short term capital markets and now find themselves drawing on the sovereign capital positions of their respective nation hosts to keep the juices flowing. All this based on the inability of the FASB to differentiate between what is perfectly fine for an Insurance company's long term needs and the use of those same actuarial tools by other groups that access the financial markets.
FAS157 was an honest attempt to prevent the creation of Zombie banks as occurred from the unbalanced valuations given by Nipponese financial institutions to themselves during the collapse of their banking system from the late 1980's. The Nipponese argued that the banking industry should be allowed to work the numbers like an Insurance company does and look at the long term capital return value of an asset held and ignore the short term implications of the values since the asset is a basis for long term capital strength and is not being held for trading purposes. This would have been a great argument if the modern world had a closed loop depositor base like the monolithic Nipponese institutions have been able to keep in their country. Further, it would have been a much more viable argument if these same Osaka and Tokyo based firms did not hyper inflate the valuations to justify over lending to approved insiders. A bargain was struck and the day of reckoning was put off until 2010 in return for the access to localized cheap capital, that which is commonly refereed to as the carry trade.
On its own, FAS157 would have not created the havoc it has...however, those in the old FMWatch were more than happy to use it in the campaign to destabilize FNMA and Freddie Mac. The argument was that they, FMWatch, could do everything the GSA's could do and it was not fair that there was competition that had a lower cost of funding. And of course, we have all seen what happens to the US lending markets the minute we pull the rug out from under it by shutting down these GSA's. These same FMWatch people don't really trust each other, causing this freeze up we are now all enjoying.
Further, there has been a general misinterpretation of the amount to be written down verses the capacity of the asset to be recovered. There seems to be a disconnection between an asset not giving off cash flow, and the capacity to eventually recover the capital invested in the asset. A piece of vacant land has no cash flow, but it has value in that it can be sold. If one can reasonably expect to convert an agriculturally zoned property with it's lower tax base to a higher and better use commercial zoning, then it would be unreasonable to argue that it has no value as a commercial property if all around it there is commercial development and the local gov't agencies have shown a capacity to move forward and cooperate in allowing the new zoning and it's valuable increase in tax base for that community. Yet on paper, in a mark to market world as it is being misapplied today, that land would be given no value as the zoning has not yet happened and if it had to be sold today, it would be as an agriculturally focused property. In that same vein, the real estate markets in the US have a small problem called demographics. In spite of the attempts of many individuals to hold back the herd, there are now 300 million people between these teeming shores and there are about 3 million people per year looking for a new place to call home...this creates a regular flow of new individuals that have a need for a roof over the pillow they use to rest their tired souls. FAS157 seems to act as though the black plague is about to return and somehow we are going to lose a few million people and not have any warm bodies looking to fill up these empty spaces. Granted, the market has seen one too many McMansions built and sold to people who can barely afford a big mac let alone having the capacity to pay a 4,000 per month mortgage, but at the end of the day, there is a want and need for housing and the sudden
suggestion that there will be empty homes and no one wanting to live in them makes for great television but is not based on factual realities.
Yet these same accounting entities that have so much gotten caught up in CYA type logic to prevent them from meeting the fate of Arthur Anderson/Accenture with its Enron mess, THEN turn around and have no problem dancing to the tune of the NYSSA who has 10,000 lunatics who insist that earnings must be 'even' and 'pretty'. This leads to all types of accounting recombobulations in the 13th week of the quarter by public corporations. That's ok, but for some reason we need to write down these long term potential losses from loan pools...right now...
FAS157 may have begun as a noble attempt to create an even and fair playing field in respect to delivering useful information to the investing public, but along with the FMWatch crowd and the changes in the Short Sale Uptick rules and Basel 2 Tier 1 and Tier 3 issues coming into play, this was not thought through in respect to the collateral damage it was allowed to cause.
Further, the losses taken do not represent the actual potential losses. On Threadneedle Street, a recent report suggested the losses to be in the range of 2.8 Trillion Dollars. Or was that the writedowns...Most debts get paid at no less than 70 cents on the dollar when they are real estate based. Those who have suggested the low down payment issues create no incentive for borrowers to stay in the home neglect to review the data in the United States after World War 2, when the returning American soldier was given a benefit(which still exists) to purchase a home with no out of pocket capital. The original no money down deal. There is no evidence that the veterans have not shown respect for the debts on a home they purchased. In fact, the no money down program helped build up the economy and there were no lasting problems from the idea that giving someone a roof over their heads, that they own, without forcing a large down payment has any negative effect on the real estate market.
There is currently a shake out going on that can not be turned around. Those anointed ones with access to government largesse who will be given access to the keys to the vault will do what has always happened in these times. The point in time where we sit today is one of transition.
But at the end of the day, the realities of Capital are amusing. A financial institution does not really need any capital. It is in the business of managing access to capital and using that access to then absorb cash flows with which to make that access work. Many lenders chose the viable and stable cash flow that comes from mortgages. So what if the asset under the cash flow is not equal to its sale value today,IT IS NOT being sold today. In fact, as future Fed Chair Marriner Eccles stated in his February 1933 testimony to Congress, Money has no utility or economic value except to serve as a medium of exchange. Capital today sits in that some position. Although many were thankful that the Clinton administration was able to find enough revenue to reduce the Debt of the Federal Government, it had the collateral effect of reducing the acceptable available treasuries that are used around the world as a substitute for any gold standard, since there is not enough gold to go around to allow any type of gold based currency. While the world economy grew, the access to Gov't paper became a problem, and thus began the march of non- USA buyers of Treasuries who needed to find capital in order to properly claim enough Tier 1 Capital to grow...The slippery slope came as those items ran out, there was a call for other assets that could be classified as Tier 1.
This is how we find ourselves with Credit enhanced sub prime mortgage paper sitting in the vaults of so many institutions around the world. One of the largest lenders in the late 20th century for Sub Prime Loans in the USA, was an operation known as THE MONEY STORE. They had what is known as yo-yo houses...homes that would be resold over and over again to new buyers because the Sub Prime borrowers would default at a 20-30 % ratio. Yet there hardly ever were any losses, as there were almost always buyers willing to borrow at high rates to take advantage of the great tax breaks that exist for home ownership in the USA. That these sub prime mortgages, under FAS157, would now need to be written down to such a degree that they need to be on a lenders books for less than 75 cents on face value has no historical basis. Even in the depression, the HOLC moved forward and made payments affordable and stretched out amortization's and allowed the value of the homes to stabilize at a price that may have seemed favorable at the time , if not inflated, but the current face value of most mortgages are nowhere near the increased underlying value of the home that will exist at the time of sale. That was the experience with the HOLC loan pools as they were paid off 15 years later. The Adler report in New York State, which gave us a solid look at the foolishness that existed back then with loan pools and guarantees, shows that the unfortunate disregard for reasonable underwriting standards today is no where near as crazy as it was in the depression. In fact, thoday's market problem was the faith people have in the realities of the growth factor in the population. The common man understands the danger of the four horsemen of the economy ...Inflation, taxes, interest rates and lawsuits...and thus moved into real estate as a hedge against these 4 issues. Why the FASB chose to push so hard on FAS157 is hard to understand. The economic history does not suggest there is some reason to not expect demographics to do its job and force the market forward.
At the end of the day, is it the old houses of finance trying to keep the status quo ???
Will the market be allowed to kill the dinosaurs, or will those in the seat of power, who refuse to adjust with the opportunities of the times, be allowed to drag us back to the stone age with the wrong mindset.
FAS157 needs to work based on the realistic capacity of the majority of the market players to be able to recover the asset value at a future date. To suggest that everyone has to act like they will be the one person without a chair to sit on when the music stops playing is not based on any historical or projectable values or information.
About 50,000 people each year die in automobile accidents. Much of it is preventable if we would insist on better training of individuals to keep a drivers license and perhaps by designing roads better to prevent chronic issues at key locations. Today 140 people will probably die in an automobile accident. The chances of it being any one person is rather slim. Based on current interpretations of FAS157, everyone should stay home and hide under a bed.
Mark to Market has become mark as if Herbert Hoover were president. And although Richard Nixon was his cousin, even in the dark days of 1974 no one thought the entire system was going to fall apart. Mark to Market seems to be getting rated as Mark to Fire Sale. What seems to be getting left out of the formula is if and when I needed to sell, what will it be worth THEN...not let's assume I am going to sell this today.
There might be some value in creating a footnote or side bar or financial statement that plays out when these assets are expected to be liquidated and what the value is projected to be then...a striped treasury has the coupon and the zero...what is the value of the zero today as against what it will be worth at time of expected sale/liquidation.
The financial system as we know it today is a ghost. We have crossed the rubicon, there is no turning back. The real question is how do we reconstruct the system and make sure we are not running so far away from that which we have found to work.
FAS157 was a good idea that has been over analyzed, over enforced and not considered properly in respect to the damage it would do at this moment in economic history.
What something is worth is a great question that needs to be tied to what it is worth WHEN it is time to sell it. The notion that those who might be technically underwater on the home they own will abandon en masse the roof over their head has no basis on the facts that are of value. Does the borrower have the capacity to carry the debt service ? Is the property in one of the majority of locations which will see an increase in real estate values due to demographics ?? If people were more concerned about the value of something verses if they can afford to handle the payments, why then does not the majority of new car buyers abandon the cars they drive 60 days after they leave the car dealers lot with the title ??? In those cases we know the value is below the debt in 90% of the cases, yet people keep making the payments ...
What is the actual default/non performing rate on mortgages in the USA ??? How does this connect to the massive losses that are being booked at these lenders ??? It does not connect. The FAS157 rule is being applied in a manner that goes well beyond the facts in respect to the loans and the performance on these loans. The only real write offs might have to do with exotic CDO squared transactions that were designed to mimic the actions of subprime loans in a way that was not based on historical norms... At most the write-offs should be sitting at $400 Billion, yet the world has seen numbers at multiples of this.
Please review the comments by these same players during the SL crisis. Then we were also going to fall into the abyss. The numbers quoted were $ 500 billion plus. The real cost(GOA 96-123 report page 9) was less than $ 90 billion. Even congressmen get this number wrong when speaking in public.
Please don't throw the baby out with the bath water. FAS157 must be adjusted to reflect the value of the asset, it's current cash flow value and the expected return of capital at time of maturity or sale. Not what a couple of quit claim deeds might be worth in Kosovo in the middle of the Balkans War with sniper fire ringing in your ears.