Thursday, April 2, 2009

The Tale of Political Influence in Changing Accounting Rules; Nassim Taleb on CNBC

For those who are not familiar with Nassim Taleb he is originator of a now very popular term called the Black Swan theory.

The Black Swan theory (in Nassim Nicholas Taleb 's version) refers to a large-impact, hard-to-predict, and rare event beyond the realm of normal expectations. Unlike the philosophical "black swan problem", the "Black Swan" theory (capitalized) refers only to events of large consequence and their dominant role in history.

I now use this term facetiously to explain almost everything because people who wish to take no blame now use "Black Swan" as a blanket explanation. Back in the day they used to be called "mistakes", "errors" and "$*(@*#(@ ups". Now? "It was an unknowable Black Swan event".

Nassim was on CNBC talking sense earlier this week; saying such things as those who brought us here should not still be in charge of "fixing things" ... and on the eagerly anticipated "mark to market" rule change all the capitalists pray for, he says it is ridiculous. We go there by lack of transparency and now as a solution we want... more lack of transparency (surely there is a counter arguement but I won't make it here - certainly there are some sensible middle grounds that will be ignored) What scares me most are our so called "independent bodies" which are supposed to be free of political pressure (Federal Reserve, Financial Accounting Standards Board) are now overrun with politics. Stuff like this...
  • U.S. Representative Paul Kanjorski said regulators must act “quickly” to give companies more leeway in applying the fair-value accounting rule that banks blame for exacerbating the financial crisis. “If the regulators and standard setters do not act now to improve the standards, then the Congress will have no other option than to act itself,” Kanjorski, the Pennsylvania Democrat who leads a House Financial Services capital markets subcommittee, said at a hearing today.
  • Lawmakers pressed Financial Accounting Standards Board Chairman Robert Herz and James Kroeker, the Securities and Exchange Commission’s acting chief accountant, to issue improvements to the rule as soon as possible.
  • You do understand the message that we’re sending?” panel chairman Paul Kanjorski, a Pennsylvania Democrat, asked Herz.
  • We do have to have you move now,” House Financial Services Committee Chairman Barney Frank told regulators at the hearing.
  • The financial institutions and their trade groups have been lobbying heavily,” Herz said in an interview after the hearing. “Investors don’t lobby heavily.” The political action committees of banks including Citigroup, Bank of America, Bank of New York Mellon, Wells Fargo and banking trade groups contributed money to Kanjorski’s re- election campaign last year, according to the Federal Election Commission. Citigroup gave $6,500, Bank of America $7,000, Bank of New York $8,000 and Wells Fargo $13,000.
As Floyd Norris says:
  • If mark-to-market accounting is to blame for the current financial crisis, then the National Weather Service is to blame for Hurricane Katrina; if it hadn’t told us the hurricane hit New Orleans, the city would never have flooded. This is the logic the bankers are using, and they are getting sympathetic ears in Congress.
  • They say the problem, in short, is not that the banks acted irresponsibly in creating financial instruments that blew up, or in making loans that could never be repaid. It is that someone is forcing them to fess up. If only the banks could pretend the assets were valuable, then the system would be safe.
  • It is true, as the bankers argue, that valuing illiquid instruments is tricky. And it is true that markets can overshoot. Some of these securities may well be undervalued now. But the solution is not to go to what Robert H. Herz, the chairman of the Financial Accounting Standards Board, calls “mark-to-management” accounting.
So here is the good news! Via Bloomberg
  • Four days after U.S. lawmakers berated Financial Accounting Standards Board Chairman Robert Herz and threatened to take rulemaking out of his hands, FASB proposed an overhaul of fair-value accounting ...
  • By letting banks use internal models instead of market prices and allowing them to take into account the cash flow of securities, FASB’s change could boost bank industry earnings by 20 percent, Willens said. Companies weighed down by mortgage- backed securities, such as New York-based Citigroup, could cut their losses by 50 percent to 70 percent, said Richard Dietrich, an accounting professor at Ohio State University in Columbus.
  • The changes proposed on March 16 to fair-value, also known as mark-to-market accounting, would allow companies to use “significant judgment” in valuing assets and reduce the amount of writedowns they must take on so-called impaired investments, including mortgage-backed securities.
  • FASB’s acquiescence followed lobbying efforts by the U.S. Chamber of Commerce, the American Bankers Association and companies ranging from Bank of New York Mellon Corp., the world’s largest custodian of financial assets, to community lender Brentwood Bank in Pennsylvania. Former regulators and accounting analysts say the new rules would hurt investors who need more transparency, not less, in financial statements.
  • Officials at Norwalk, Connecticut-based FASB were under “tremendous pressure” and “more or less eviscerated mark-to- market accounting,” said Robert Willens, a former managing director at Lehman Brothers Holdings
  • What disturbs me most about the FASB action is they appear to be bowing to outrageous threats from members of Congress who are beholden to corporate supporters,” said Levitt, now a senior adviser at buyout firm Carlyle Group and a board member at Bloomberg LP, the parent of Bloomberg News. (that's Cramerica Mr. Levitt, for the corporation - by the corporation... if you donate enough to a political campaign you too will find out how your path is greased to the upside)
  • Conrad Hewitt, a former chief accountant at the SEC who stepped down in January, said representatives from the ABA, American International Group Inc., Fannie Mae and Freddie Mac all lobbied him over the past two years to suspend the fair- value rule. (ooh a whose who of now governnment controlled firms - wonder what why they wanted such a change? Oh never mind - self explanatory)
  • Executives “would come to me in the afternoon with the argument, ‘You’ve got to suspend it,’” Hewitt said in a March 25 interview. The SEC, which oversees FASB, would reject their demands, and “the next morning their lobbyists would go to Congress,” he said.
  • Banks and insurers wanted to value securities at prices they bought them for, Hewitt said. His response: “If you carry them at 100 percent of what your purchase price was and they are worth 50 percent, is that fair to the investor?” “I don’t think there was anything that would have pacified them,” short of a suspension, he said. (so in English, if you bought your home for $325K in 2006, and its now only able to fetch $200K - well just mark it down as $325K if you are a bank - that's fair and balanced. And transparent. You can say the market is not functioning correctly - and prices are just plain wrong. Or not enough homes are selling in your market to fairly price yours. Now multiply that over trillions of assets. And go buy some bank stocks)
So it's wonderful news wouldn't you say? 20% more profits in an instant for an entire industry! Goooo Team Lobbyist! I knew it was the slimy green eye shaded folks that were at the bottom of all this; eliminating their heavy handed rules made us all that much richer. Problem solved.... bull market commences after the decision later today.

Anyhow, I digress - let's get back to Nassim....

Via CNBC (11 minute video full of fun - actually a very interesting, wide ranging video)

Altering mark-to-market accounting rules would bring more opacity to the financial system, said Nassim Taleb, “The Black Swan” author.

“It’s exactly like how a thermometer makes a patient look more sick,” he said in a CNBC interview. “Eliminating the mark-to-market is exactly like putting your head in the sand.”

Rather than taxpayers propping up large banks, Taleb said, the hedge fund model should be followed.

“Some go bust, some do okay, some have problems,” he said. “We don’t care. It’s their problem. It’s not society’s problem.”

Fixing the financial crisis requires a financial system with less debt and less complex derivatives, he said. The solution is not to alter the current financial structure, said Taleb, but rather, to look for “robustness” in the system.

“Complexity causes fragility,” he said. “You’re no longer riding a horse—you’re flying a Concorde. A horse doesn’t explode but a Concorde can have a problem. We now have a Concorde in our hands.”

[Dec 4, 2008: Nassim Taleb on Charlie Rose]

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