More Pirates

From Floyd Norris of the New York Times comes this tale of accounting subterfuge. I cannot improve on his telling of it:

Few things matter more to banks these days than asserting their right to conclude that market prices for toxic securities are “distressed” and therefore should not be used in valuing the securities. Instead, they want to use values based on their forecasts of how the securities will perform. Using political clout with Congress, the banks forced the Financial Accounting Standards Board to make it easier to ignore markets, but they are demanding further concessions.

Today the S.E.C. filed an enforcement case against a mutual fund that specialized in mortgage backed securities, the “Ultra Short” fund run by the Evergreen Investment Management Company. “Short” in this case does not mean short-selling; it means short-term fixed-income securities.

In 2007 and 2008, that fund appeared to be the best performer in its category, simply because it refused to mark down the values of mortgage-backed securities it owned. Then, the S.E.C. says, it tipped off selected holders so they could get out before it marked down the value of its portfolio. The company agreed to pay $33 million to former shareholders of the fund, plus assorted penalties to raise the total cost to $40 million.

One claim in the S.E.C cease-and-desist order captures the extent of the unreality.

On May 23, 2008, a different Evergreen fund bought a collateralized debt obligation backed by subprime mortgages for $9.50, down from an issued value of $100. As it happened, the Ultra Short fund owned that very security, and was valuing it at $98.93.
The S.E.C. states:

"After learning of this transaction, the Ultra Fund’s portfolio management team contacted the selling broker-dealer to determine whether the sale was “distressed” (and thus could potentially be disregarded for purposes of determining the fair value of the security). On May 28, 2008, the broker-dealer responded that the security was “not coming from a distressed seller, just one that wanted to get out.” Notwithstanding this response, the Ultra Fund’s portfolio management team informed the Valuation Committee that they believed the sale was distressed and did not disclose the broker-dealer’s statement to the Valuation Committee."

So the fund valued the security at more than 10 times its market value, until it was forced to write down lots of securities.

Is a multiple of 10 possible now? Or are banks raising market values by only two or three times when they decide sales were “distressed?” We don’t know. But we know that only a year ago one mutual fund thought a multiple of 10 was quite reasonable.

Yes,those new accounting standards are sure going to help!