Month: December 2008

The SEC has announced that it:

today delivered a report to Congress mandated by the Emergency Economic Stabilization Act of 2008 that recommends against the suspension of fair value accounting standards. Rather, the 211-page report by the SEC’s Office of the Chief Accountant and Division of Corporation Finance recommends improvements to existing practice, including reconsidering the accounting for impairments and the development of additional guidance for determining fair value of investments in inactive markets, including situations where market prices are not readily available.
…
Among key findings, the report notes that investors generally believe fair value accounting increases financial reporting transparency and facilitates better investment decision-making. The report also observes that fair value accounting did not appear to play a meaningful role in the bank failures that occurred in 2008. Rather, the report indicated that bank failures in the U.S. appeared to be the result of growing probable credit losses, concerns about asset quality, and in certain cases, eroding lender and investor confidence.
…
While the report does not recommend suspending existing fair value standards, it makes eight recommendations to improve their application, including:

• Development of additional guidance and other tools for determining fair value when relevant market information is not available in illiquid or inactive markets, including consideration of the need for guidance to assist companies and auditors in addressing:
  • How to determine when markets become inactive and whether a transaction or group of transactions are forced or distressed
  • How the impact of a change in credit risk on the value of an asset or liability should be estimated
  • When should observable market information be supplemented with and/or reliance placed on unobservable information in the form of management estimates
  • How to confirm that assumptions utilized are those that would be used by market participants and not just a specific entity
• Enhancement of existing disclosure and presentation requirements related to the effect of fair value in the financial statements.
• Educational efforts, including those to reinforce the need for management judgment in the determination of fair value estimates.
• Examination by the FASB of the impact of liquidity in the measurement of fair value, including whether additional application and/or disclosure guidance is warranted.
• Assessment by the FASB of whether the incorporation of credit risk in the measurement of liabilities provides useful information to investors, including whether sufficient transparency is provided currently in practice.

The full report is available on-line.

Whoosh! This will take a certain amount of work to understand!

The Federal Reserve has announced:

that it expects to begin operations in early January under the previously announced program to purchase mortgage-backed securities (MBS) and that it has selected private investment managers to act as its agents in implementing the program.

Under the MBS purchase program, the Federal Reserve will purchase MBS backed by Fannie Mae, Freddie Mac, and Ginnie Mae; the program is being established to support the mortgage and housing markets and to foster improved conditions in financial markets more generally.

Of great interest are the published FAQs:

How will purchases under the agency MBS program be financed?
Purchases will be financed through the creation of additional bank reserves.

It is not clear to me just what this means. Will the Fed be getting a deposit from Treasury, financed by sale of Treasuries? Or will they finance it via a bookkeeping entry, aka “printing money”?

One way or another, watching the Fed’s balance sheet has been a lot more interesting than normal lately!

Update, 2008-12-31: Another interesting thing about this is the lack of duration hedging. Players will often hedge the duration hedging of an MBS portfolio by taking market action in Treasuries and entering fixed-receive swaps:

As a consequence of record levels of refinancing in the second half of 2002 and the first half of 2003–which, by our estimates, encompassed roughly 45 percent of the total value of home mortgages outstanding–MBS duration fell to exceptionally low levels. As mortgage and other long-term rates rebounded last summer, a consequence of rapidly improving economic conditions and the fading of deflationary concerns, refinancing fell sharply, removing most downward pressure on duration. Holders of MBS endeavoring to hedge developing interest rate gaps rapidly shed receive-fixed swaps and Treasuries, and these actions markedly aggravated last summer’s long-term interest rate upturn.

There’s a comment on an unsigned blog:

Credit spreads on corporate debt have generally made yet another explosive move higher, as treasury yields have imploded in the recent blow-off move in government notes and bonds. Note in this context that we have once again a case of ‘unintended consequences’ at work here, as the implosion in treasury yields can be attributed directly to the Fed’s decision to [monetize] $800 bn. in MBS and ABS, forcing duration hedging of large MBS portfolios.