the "Mark to Market" song

I've been catching up on reading and other work for the past few days and so haven't been doing much posting, but I couldn't resist this:



(ht Calculated Risk)

Bernanke on Valuation

In a speech that helped drive markets upward today, Federal Reserve Chairman Ben Bernanke talked, in part, about the problem of valuing assets, a problem that to my mind lies at the very heart of the crisis in the financial system. Long story short, he insisted that valuation is a problem because of the competing issues of procyclicality and transparency -- in plain English, between driving the banks deeper into insolvency and telling the truth. Key passage:

The ongoing move by those who set accounting standards toward requirements for improved disclosure and greater transparency is a positive development that deserves full support. However, determining appropriate valuation methods for illiquid or idiosyncratic assets can be very difficult, to put it mildly. Similarly, there is considerable uncertainty regarding the appropriate levels of loan loss reserves over the cycle. As a result, further review of accounting standards governing valuation and loss provisioning would be useful, and might result in modifications to the accounting rules that reduce their procyclical effects without compromising the goals of disclosure and transparency. Indeed, work is underway on these issues through the Financial Stability Forum, and the results of that work may prove useful for U.S. policymakers.

Surely there are better ways to support credit markets than to fudge the numbers on the real health of the banks. Bernanke seems to suggest this, but is short on details. Moreover, markets are not fooled, as reflected in dropping share prices. And regulators surely understand how a lack of transparency precludes effective supervision. If the emporer is naked, we would save ourselves a lot of trouble if we just told him.

Fair Value or Fantasy

General Electric may be answering the question of what happens when we tell each other the truth about asset values, or absent this, when investors begin to suspect the truth.

Driven mainly by fears about its financial division, GE shares have declined by more than half since early January. The reason, according to a report on Bloomberg today is that the company reports only 2% of its assets at prices that approximate market values. And this, the report notes, strikes fear into investors as

“The notion of having 98 percent opaque and 2 percent valued with clarity is something that by its very nature would make investors nervous,” said Robert Arnott, founder of Research Affiliates LLC, which oversees $30 billion in Newport Beach, California and owned 481,201 GE shares as of Dec. 31. “Having some clarity on what the other 98 percent is worth is valuable.”

Not to be outdone in the understatement sweepstakes, GE spokesman Russell Wilkerson responded

We recognize there is a need and an opportunity to do more to improve disclosure and transparency.

Do tell.

If we are ever going to get to the bottom of this mess, we need to at least begin to tell ourselves the truth about balance sheets, particularly in the financial sector.