What State Legislators Can Do About Our Nationwide Crisis

First, I realize there are many contributing causes of our problems:

• 
  Imprudent mortgage lending.
• Overexposure to risky assets, such as collateralized mortgage and other obligations.
• Availability of Fannie and Freddie as crutches.
• Easy credit from the Federal Reserve
• Soaring gasoline prices during the summer of 2008, whether from Chinese competition, desire of various parties to influence the election, etc.
  

These all served to make our economy unstable and volatile. Nonetheless, the one underlying cause was accounting, which makes this primarily an ACCOUNTING CRISIS. Fair market values for financial institution assets have been around since the 90s. However, sometime in 2007, the definition of market value, at least for collateralized assets, got corrupted to fire sale value. Management's judgment in computing the present value of cash flows could no longer be used to fair value assets - only valuations of "market participants." When trades of assets dried up, the only option left was use of fire sale value.

At the same time, the leading bank and probably other banks had been holding riskier assets off the balance sheet and not consolidating. Similar practices were followed by Enron, which all had the ultimate result of hiding true financial conditions from investors. Sometime in late 2007, this apparently changed and these assets had to be re-consolidated.

Accounting matches applied to an unstable tinder box set off the September, 2008 panic.

Arguably, some correction due to the above contributing causes had to take place. However, there are numerous fallbacks in place that would have provided considerable chance for a "proverbial soft landing" of the economy. With accounting changes as the last straw, this became impossible.

At the same time, and connected to the crisis, because of AIG's problems with non insurance subsidiaries, we have the fresh momentum for OFC.

Given all this, what can state legislators do?

Bring pressure to bear on your state accountancy boards. These control CPA licenses, even though we know the SEC and PCAOB agencies also exert great power. Demand that Boards in turn petition these two agencies and FASB:

• End any carryover of fire sale accounting for otherwise performing, albeit injured, assets.
• End once and for all the practice of not consolidating riskier assets on balance sheets.
• Demand that CPAs report to state Boards and to you any bullying by any agency to continue requirements for fire sale market value definitions.
• Demand that your state insurance departments not permit any state by state deviations from the NAIC decision to reject the recent proposal for liberalizing statutory capital requirements. Originally, I thought several of these proposals, especially for reserves, had merit. However, state insurance regulation is now in a hostile goldfish bowl. Any departures from uniform nationwide decisions (known as “permitted practices”) make state regulation look weak and inept, however unjustified. Also, at least one large insurer, while pushing for these liberalizations, is also pushing for OFC.
• Demand at least from state banks that any assets deemed “toxic” be reported to
  legislators as in default, providing less cash flow than originally estimated, or merely risky. If done on a nationwide basis, this should show that toxic or troubled is not synonymous with default.

Other demands are more well known, that basically involve your petitioning Congress or petitioning your own voters to petition Congress:

• Don’t revive Fannie and Freddie as dumping grounds for riskier assets.
• Since banks have published capital standards, investigate any reports of federal or state bank regulators imposing arbitrary writeoffs of assets.
  

The above views are my own and are not necessarily those of any professional organization.

Norman E. Hill, FSA, MAAA, Member AICPA, ASCPA

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Labels: accounting crisis, AIG, Big Banks, Current Crisis, economic crisis, norman e hill

posted by Norm  Thursday, July 02, 2009