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Cracks beginning to show?

Posted by Richard Monday, October 13, 2008 ,

Headline reports from the Paris "summit" – this one of the 15 eurozone members plus Gordon Brown and "hangers on" like Barroso – speak of "a plan to confront the financial crisis which will involve hundreds of billions of dollars of new initiatives to head off a feared 'meltdown'".

Thus we hear of Sarkozy saying that governments would "buy into banks to boost their finances and guarantee inter-bank lending." "The EU," we are also told, "will ask the United States to help organise an international summit to reform the global finance system."

Details are sparse as it has been left to each member state to make their own arrangements – although it is being suggested that Germany alone is prepared to put €3-400 billion in the pot. The precise plans, we gather, will be announced after simultaneous Cabinet meetings being held today in Italy, Germany, France and elsewhere – before the markets open.

The guarantee on inter-bank lending is, of course, crucial. But, given the effect that the promise of a British guarantee has had on the Libor, no one is holding their breath.

In fact, at least one financial blogger is more than a little sour, warning that "there is a price to pay for those government guarantees." Blanket guarantees of everything, he writes, will eventually end in a collapse of some major country or some major currency, the break-up of the EU, or a global depression of some sort, perhaps all of the above.

These governments are simply transferring the risk of bank collapse to their economies as a whole, "betting the farm", so to speak, that this will hold the line. But it is rather like tying oneself to a rotten tree in a storm in a bid to stop it being blown down. It might be better to cut the rope.

All of that makes another of Sarkozy's comments rather interesting. He is calling for "new accounting rules for banks" to be enacted "without delay". This looks hopeful except that he specifically declared: "On the reform of accounting norms for valuing bank assets, we got the agreement of the British prime minister on the proposal we will make on Wednesday with President Barroso."

This is our old friend the "mark to market" rule and the reference to Wednesday is to the autumn European Council meeting - something the journos will insist on calling a "summit". Thus, it looks like the commission will be tabling formal amendments on that day.

But, from the tenor of the comments, it looks like we are dealing with the sham reform announced at Ecofin last week, a story already picked up by Reuters.

If that is all the "colleagues" have to offer, it is not very much. Later today, the US SEC is expected to announce its definitive "guidance" on the revised application of the rules, about which the commission is making such a song and dance.

In the US, this has not quelled demands for a complete suspension of the rules. John Allison, chairman and CEO of BB&T - a well-capitalized North Carolina bank holding company with assets of $136 billion – stresses a point similar to that made by the TPA. He is saying: "If we had fair value [mark to market] accounting, as interpreted today, in the early 1990s the United States financial system would have crashed."

But, if the "colleagues" are still playing their games in Europe, down in the grass something is stirring. On Friday, Reuters was reporting an intriguing comment from Thomas Steffen.

Steffen is the chairman of the German Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS) and is also in charge of insurance supervision at the financial watchdog BaFin. He is voicing concerns about "fair value" and has stated, "We should not change the principles, but we should be ready to revisit the concept of [in]active markets, where markets obviously do not provide appropriate prices."

Then, we heard last night from Klaus-Peter Mueller. He is another German financial luminary, president of the BdB federation of German banks and supervisory board chairman of Commerzbank AG (CBK.XE). This is a "big cheese" by any measure.

Mueller thinks (or, at least, is saying) that the outcome of Friday's G-7 (G-1.32?) meeting and yesterday's Paris summit "could be the turning point in the current financial crisis" – although he did not state the direction in which the turn might be made.

Crucially, he regards a recapitalisation of banks as "only a temporary measure," backing "government plans" to modify accounting rules. As lessons to be learned from the current crisis, Mueller says, "accounting rules have to be modified."

Echoing Thomas Steffen, he suggests that, "… one shouldn't juggle the principle of a fair-value-valuation. This principle remains right." But he adds, "if products due to an extraordinarily market situation can't be regarded as tradable then this must be taken into account on the balance sheet singularly." In the medium term, therefore, "a reform of the capital requirements directive is important."

If this is not exactly an expression of urgency, the staid and formerly totally obscure International Accounting Standards Board is getting its skates on. According to the Financial Times it is meeting today, in a bid "to head off the threat of action by the European Union" – stirring stuff indeed.

Unfortunately, it is confining itself to considering the "sham" reforms, which the FT says could only ease "future strain on balance sheets". It would not provide an immediate - and urgently needed - boost to current asset values.

However, European Central Bank governing council member Christian Noyer is joining the fray, agreeing that the rules "need to be overhauled" – a more fundamental reform. But he is cautioning against a move during the financial crisis.

"Noting that valuation rules may not be optimal for all instruments in all market circumstances," he declares, "does not mean that they should be changed in the midst of a crisis." A sudden change of the rules as markets collapse could raise moral hazard issues and amount to "valuation forbearance" - allowing companies to gloss over losses on their portfolios.

Thus, on both sides of the Atlantic, the pressure does seem to be building for a more fundamental reform of the "mark to market" system, despite the determination of the British MSM and the chatterati to ignore this issue.

Whoever would have thought that accountancy could be so exciting – or have I completely lost it?

  • Other posts on the financial crisis here.


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