Another mid-game SEC rule change

Every possible effort is being made to make our banks healthier. And if that is not possible, then to at least make them appear healthier. The SEC just passed a new rule with this second aim in mind.

And I'm not sure how much it is really going to do, since the rule change will allow companies to place higher values on stricken assets that have already been "marked down." As I point out below, many companies have not yet done this, so how much of a gain will result is questionable.

Here is an excellent article on the rule change.

[quote]Some economists are attributing much of the current financial crisis to something as mundane-seeming as accounting.

The Securities and Exchange Commission and the Financial Accounting Standards Board have just made an announcement that, dry as it sounds, may mean a great deal: "When an active market for a security does not exist, the use of management estimates that incorporate current market participant expectations of future cash flows, and include appropriate risk premiums, is acceptable."

There is no market right now for the worthless mortgage-backed securities -- that's one of the reasons we're in this crisis. That means financial institutions that are holding them must value them at zero, or near to it. That makes the institutions themselves worth much less.

The SEC has just said that the financial institutions themselves can now place a fair value on the assets. That could raise a whole other set of issues, but for now, let's just deal with this one.

Accounting is not something that ordinary taxpayers think about much, but it could hardly be more important to businesses: It's the value they place on what they own, what they owe and what they can sell.

An odd-sounding accounting phrase at the heart of this is something called "mark-to-market" accounting. Many think that if this requirement were ended, the crises could be eased.

Simply put, mark-to-market accounting requires companies to set the value for the assets they own at the price they could fetch on the open market right now. The prices must be "marked to market;" hence the phrase.

What does that have to do with the current crisis? The root problem now is that financial institutions have been caught holding value-less, or "toxic," assets on their books, such as the mortgage-backed securities based on sub-prime mortgages that have defaulted.

The government believes that those assets will be worth something soon -- that's why they want to buy them in the $700 billion Wall Street rescue plan. But under mark-to-market rules currently required, they are worth almost nothing, threatening those who hold them with insolvency.

If the holders could place a value on the assets equal to the estimated value they should bring in the future, suddenly the balance sheets of these financial institutions would look a lot healthier.[/quote]

Now, if lots of companies had taken their assets and put them through the mark-to-market wringer, they could potentially reverse that process and now record those paper gains on their books.

However, instead of "marking-to-market," many companies opted instead to park their troubled assets off into another arcane accounting cul-de-sac called "Level III" assets.

Definition of Level III:

Assets whose fair value cannot be determined by using observable measures, such as market prices or models. Level III assets are typically very illiquid, and fair values can only be calculated using management estimates or risk-adjusted value ranges.

Here's a snapshot of some financial companies and their Level III asset counts from August. Clearly, as you scan the list you will note that several of those companies are notably absent from the September landscape.

Numbers are in millions (meaning, for example, that Citibank has $154.6 billion in level III assets).


This new SEC rule change is specifically targeted at the remaining members of this list, especially those at the top. Just for fun, compare the total equity of the organizations (the first column of numbers) to their Level III assets, and you can see why there is great concern that these Level III assets not be marked to their current market value (presently 'zero' for many).

I don't know for sure how much this new rule change will help; that depends on how many companies already announced writedowns that can be reversed now. My only point here is that companies with large Level III asset pools have already been hiding the dirt deep in their balance sheets, carrying them at "management estimates."

The SEC rule change will almost certainly not allow Level III assets to be valued any higher than they already are. So, no big change on that front.

This is a companion discussion topic for the original entry at

Really, didn’t we learn from the Japanese that letting insolvent banks fester is the absolute worst thing that can be done? We’d, frankly, be better off recapitalizing them on the tax payers backs then this bullshit.

Sigh, wheres a politician with the guts to murder banks when we need one?


[quote]The government believes that those assets will be worth something soon-- that’s why they want to buy them in the $700 billion Wall Street
rescue plan.[/quote]Forgive my stupid question as I’m still learning (great site by the way!), but why does the government think the assets will be worth something soon? That is, under what circumstances could these bad assets become good assets again?

Course because of it’s objective way of looking at things and the very important notion that you have the right to change your opinion as new facts come into play, but this site is beginning to look more and more like those perma-fear mongering sites where the readership are all members of the NRA and all have their own home made bomb shelters. How can conclusions be drawn from this new Mark to Market rule when we don’t know what assets have been written down to close to 0? The liquidity freeze has left many assets, some of which are not worthless or properly marked. I do agree that this opens the door to a slippery slope and that the temptation to incorrectly mis-mark assets will be great but one thing to implement would be criminal charges laid upon fraudlent marks. It’s not just this that I’ve noticed, change in your site… the overall independent third party view that looks at all possible explanations doesn’t seem to be there as much and there’s no attempt to bring about arguments that would oppose your current views just to ‘test if it holds water’. Suggestions of price fixing and conspiracy theories over short term oddities in price behaviour just fuel the paranoia. I personally did well making money on buying euro call options but luckily after doing some soul searching, sold them yesterday because I realized that if the theories of mass doom are correct, assets all correlate. The Euro is in just as much danger, if not more, than the USD because the Fed has more of an ability to affect change than other central banks (good or not, that’s the fact) so even if the USD is weakened, it might not weaken against other currencies which are in just as much ‘doo doo’. I’ve switched to silver as it is statistically cheaper to gold but there are probably other forces at work which should also be investigated or contemplated. Please don’t lose your objectivity in all this, I know a few successful calls and many pats on the back can often lead to hubris. There have been many doomsayers in the markets and there always will be. They are now having their day of reckoning but they also missed out on a pretty big bull run. I never took you for one of those and please don’t be offended by my comments. I really appreciate the work you do but these are just a few of my personal thoughts on how I have seen this site morph into over the past few weeks… maybe it’s from reading all the comments from gun toting NRA folk that suggest people buy flare guns if they don’t ahve a gun license because it can cause significant damage at close range sighs.


The theory behind that idea is that the market, facing a glut of assets being dumped all at once, is creating a downward price pressure that is misplacing the value of the asset well below the end summation of the money delivered.

One way to think of it would be this: Imagine that you are in the deserts, dieing of thirst. Now, you have a gold bar on you, and someone is willing to sell you a canteen of water for that gold bar. If you refuse, you’ll die. Do you take the offer?

There is, of course, some validity in the argument that many of these ‘assets’ are undervalued. Unfortunately, most of these assets are so complex that nobody is sure what exactly that value is. It could be nothing, or it could be as high as 95% of the face value. Further, it varies for each and everyone of them.

SECs idea however, is particularly troubling because it is akin to saying: "Please hide your losses! That way you won’t go ‘bankrupt’". It is as though SEC believes that this problem wouldn’t exist if people weren’t aware of it. It all goes back to my Shrodinger’s Bank joke =). If you don’t observe it, it’ll never die!

A better solution would be to change the leverage limits on banks so that the leverage allowed when taking action that ‘increases debt’ is different than the leverage allowed before coerced selling of assets. This would allow banks some wiggle room to sit back and wait for assets to recover (if they ever do), or sell at a slightly more preferential time, but would still require the maintence of a cushion to reduce the inheriant risk of failure.

Alas, that might make sense, and is therefore rejected by principle.


great post steve

where is ron paul? this is the time there will never be a better time than this. if he doesnt do any thing now he never will. this is the perfect time to introduce a monetary reform bill tho get rid of the fed. everyone in the country is finally paying attention.

if we dont get rid of the rothschilds and their toadies we will be no better off ever

we will be the argentina of north america

thank you steve

… and re-read what I actually wrote.

I think you’ll see that you were way out of line in your assertions and assessments.

I understand these are emotional times for folks and I’ll promise to bring my best objectivity if you promise to bring yours.

Hi Chris, I’m most impressed with your site and thinking but am struggling for the big picture. I understand that we are effectively eating extracted carbon but I don’t understand why money is finite. Isn’t it just a game played by consenting adults and won’t it only end when no one wants to play any more? Won’t we always be one step away from the end of money but then find another step added by the rule makers? Isn’t this exactly whats happening now? Seems to me we are caught in Zeno’s paradox.

my apologies… you were right. I do try and take objectivity seriously and notice that you never actually stated that assets that lack a market are indeed worth zero. I read my comments again and I can see how the tone could seem overly assertive and presumptuous but that’s sometimes why the written word isn’t the best method of communication because I didn’t mean to put the accusation of objectivity solely upon you. I just have read some pretty one-sided comments from some of your readers and read other sites who have predicted doom and gloom for a decade and it just seemed (again, just my opinion) that this was quickly snow balling into one of ‘those’ sites. My call for everyone to remain objective was meant to be a general one and to always take on new information as being potential valid parts of a large puzzle. On the specific examples where markets can seem disjointed, well I’ve traded long enough in several different strategies to know that temporary hiccups to market efficiency can happen and will happen going forward but that doesn’t always mean that there was some greater conspiracy to it all. Again, my apologies, I should have written my views differently and like you want to see education spread amongst the masses so we are better able to make informed decisions going forward.

changed if the ratio of Level III assets was over a certain level and that management and directors should be made to defend their marks if scrutinized to a point where they can be held liable outside of their commitment to fiduciary duty.

were forced to mark down assets to 0 when the market wasn’t liquid? What volume or type of bid constitutes a proper mark? As a trader, I do believe in the mark to market system, I traded several strategies including distressed and high yield strategies that often had positions that were difficult to mark but we still used this system unless I could prove that value was otherwise. That’s why this ‘bailout’ looked interesting in that it created a market to try and validate asset value… perhaps it wasn’t an exercise in collecting toxic assets as much as it was to kick start the market into giving credible marks or to at least start the process of value discovery. This one’s a very sensitive but really important issue and can definitely open the doors to abuse but I also think it was one of the root causes of bank failures that might not have occured if this rule was different… I know, I can hear some readers saying that this is completely wrong and that we are headed into doomsville with or without changes to this rule but I do feel that when markets are illiquid, forcing someone to mark them to 0 is just as wrong as marking them to par.

About the "forced to mark to zero" … I supose that would be wrong but that hasn’t happened yet to any great degree that I am aware of.

That’s the whole reason we have more than a trillion dollars in Level III assets. Nobody’s been willing to mark anything remotely close to market value.

But the price discovery offered by the dumping of some of the CDO stuff (I am thinking of ML’s revent 22 cents on the dollar experience here) ran the danger of forcing similar assets to be marked down and that was fright enough I suppose.

The alternative to the SEC rule change would have been to revoke Sarbanes-Oxley so that nobody would fear a jail term for failing to mark down a similar asset.

If you know of any data as to the amounts of ‘forced to zero’ assets I would be most interested in that.

Thanks for the comments, I appreciate your reply. All I can
say is that everybody is coming at this massive change with a different
perspective and I do not feel qualified or responsible for trying to
"steer anybody right". My personal opinions of which people are the
closer to the truth and which are further has shifted so dramatically
over the years that I now bite my tounge and listen to everything as I
am no longer confident that I know which way is true north.

There are
lots of ideas, emotions, fears, hopes, plans and data that need to be
processed right now and I like the people who have been drawn to this
site via the Crash Course. We are everybody. We are people. We are
from all over the world. And I am OK to just let that be and trust that
wherever people are at, and whatever drew them here, now is a great
time to be pulling together an figuring this all out.

Because this isn’t doomngloom, this is the greatest shift of a lifetime.

So we might veer off the cart path from time to time but in our defense we are blindfolded and it’s dark out there.

CNBC or read somewhere that certain assets (not sure if they were already classified as Tier III or not) were being marked well below what some would deem as actual value. I am hoping someone reads this and can find out by talking with an analyst who may have asked management that exact same question… were there assets that you had to write down below what you felt was true value and close to 0 because of this mark to market requirement. Also, if the market was truly this illiquid and we see wild price swings where assets are marked when a trade occurs and there can be 20 points in between trades, doesn’t that mean we should be seeing mark-ups occur? What are your thoughts as to the possibility that all $700B doesn’t have to be spent to kick start the markets into going into true price discovery mode and have marks more relevant? I don’t want to take up any more of your time on this, thanks for responding to my posts so far, I feel badly for taking up your time when everyone (including me) is anxiously waiting for chapter 20 :slight_smile:

Why is money finite is an interesting and difficult quesiton to answer. In the end, it really depends on "what do you mean by money?"

It is true, for instance, that the government can print an infinite amount of cash. Tomorrow the Fed could roll out black helicopters and begin raining down a new shiny $1,000,000 dollar bill upon the citizens of the United States. Many a country has proven that the only limit to how fast a currency can inflate is how fast they can tack an extra zero to the miles of paper they are printing.

However, it is important to remember that money is just a symbolic representation of a promise, and since the number of things ‘promised’ cannot be printed and increased so easily (if they could, you wouldn’t bother printing money!), actual wealth cannot be increased by such a mechanism.

Monetary Printing is not though, exactly what Chris seems to be referring to when he says money cannot expand infinitely. He is in my understanding talking about monetary expansion through debt (I really hate that conception, it is entirely misleading. Economists need to invent a better set of terms for this.) Debt, as you should well know, cannot expand infinitely. There is a finite number of people who can be in debt, there is also a finite limit to the amount of debt that can be repaid by any individual, and finally a finite limit to the time over which it can be paid (Laws prevent debts from being passed onto the next generation, and even if they could be, very few debts can be considered stable for a 100+ year period).

Because, once debt expansion passes its limits the fiscal system on which it is based starts to collapse (because debts aren’t being repaid, and debt owners stop lending because lending imposes the risk of transferring their wealth to others) debt can be said to have very real limits. Therefore, any society whose monetary expansion is based largely on debt expansion, should be terrified of a logarithmically increasing money supply.

Of course, I’d point out that a large portion of America’s every increasing money supply is actually monetary printing. Which, as mentioned above, really is infinite. Of course, if you print too fast nobody would want your money, no matter how much you had. =)


…but unfortunately even the truth about the real position of the Fed in our society is still so new to so many folks that there is not yet enough public "outcry" for the changes that so many wise souls have told us we need to make, in the past.

I had a free market fundamentalist argue me down this past weekend, that the Fed does indeed belong to the U.S. government, and therefore the people. How do you deal with that kind of ignorance, when they are totally unwilling to do any research, whatsoever, on this subject…or any other.

Perhaps it is true: "The dumbing down of Americans." As has been so succinctly said: "there’s stuff we know, and there’s stuff we don’t know, but these folks don’t even know that they don’t know." What a sad commentary.


[quote]I had a free market fundamentalist argue me down this past weekend,
that the Fed does indeed belong to the U.S. government, and therefore
the people. How do you deal with that kind of ignorance, when they are
totally unwilling to do any research, whatsoever, on this
subject…or any other.[/quote]

Well, it is difficult to fully describe the nature of the Fed. It isn’t truly a public nor a private entity. I perfer the term Quasi-public-private.

Personally, I see a central bank as necessary. History has proven over and over again that a gold standard never stands. I however, would perfer to see it broken off as a true ‘fourth estate’ (a seperate branch of the government, whose powers are checked by congress, the president, the judiciary, and the people).

[quote]Perhaps it is true: "The dumbing down of Americans." As has been so
succinctly said: "there’s stuff we know, and there’s stuff we don’t
know, but these folks don’t even know that they don’t know." What a
sad commentary.[/quote]

Saying that American’s have been dumbed down is far too optimistic an impression of past Americans. :wink:

No really, I can’t be angry with American’s that are ignorant (but I wish they weren’t). As a working adult, I understand that urge after a long day to just ‘veg’. I also understand that many American’s have less free time then me, work overtime, and have to care for a family and a score of chores they are behind on. Given that most people don’t like politics or anything academically related, it is a bit unreasonable to demand they squeeze in a few hours here and there to keep appraised. Especially when they are mostly content about how things are going.

Now, if we had the same kind of free time as the French… Less working hours and more holidays for a more perfect union! Rah! Rah!


As an accountant that doesn’t value these types of securities I have some limited familiarity with the accounting involved.

This rule change actually won’t affect Level III assets because these assets already don’t use mark to mark for valuation (see Chris’ definition above). Not only is mark to mark not used for these types of assets but it can’t be used for Level III assets. For instance, if a company was to purchase a Level III asset that the company internally valued higher than the purchase price then the asset would be increased to the company’s calculated value.

This rule change will affect the valuations of those Level I securities for which an active market does not exist (such as mortgage backed securities that aren’t trading). Prior to the rule change these securities would need to be valued at their market price. However if there isn’t an active market that doesn’t mean that the assets should necessarily be valued at zero - it means that there is a range of values from zero up to the holding value or beyond that could arguable be the appropriate value. This means that some companies might try to hold the securities around their holding value and argue that a lower value isn’t appropriate because there isn’t an active market. This SEC rule change will help companies support this argument. First implication: assets that may have been under consideration to be written down now might be able to hold a higher value. Second implication: companies that wrote down Level I assets for which an active market doesn’t exist could now reassess this valuation using Level II criteria (i.e. management’s estimates) and this might allow them to raise the asset value.

Unfortunately there may be a tendency to have rosier expectations within the management’s estimates that don’t fully reflect that a) house prices are falling with no bottom in sight and many foreclosures can be expected into 2010 until Option ARMs reset and b) additional foreclosures that arise from a slowing economy from decreased construction, auto, and financial jobs plus the general feedback into the rest of the economy and c) foreclosures that are becoming REOs that eventually need to come back on to the market. For a detailed assessment of the California house market please refer to Mr. Mortgage’s website.

I wouldn’t rely on criminal charges preventing these rosier assumptions since I think you can appreciate the subjectivity involved.

As time passes then these internal valuations will decline as the true extent of the economic landscape reveals itself.

For those making posts I suggest we all consider the increasing traffic to Chris’ website and consider the potential impact that more dramatic comments have on new visitors and remain positive since Chris is spreading a message of a) awareness of the issues we face and, once he completes Chapter 20, b) the steps we can take.

These steps we can take are ones that we’ll need to take together.


Thanks so much for your very full reply and take most of the points you raise. Is it realy true that the lenders will stop playing if the US keeps printing money or have they, as Chris suggests elsewhere on his site, got a very vested interest in still playing?

I searched for "the end of money" after it had dawned on me that was what we were about to see and found this. I am delighted to have someone authorative to quote. What I find is that the only ones listening are the young and they don’t have the power. There seems no way to break the money mindset of my generation.


the ones that suggest flare guns are a good alternative because of their ability to do a lot of damage in close proximity… that sort of stuff just makes my skin crawl and because I value this site so much especially during times like these where I find staying informed is my best defence, that I was disappointed somewhat.