The efforts by global regulators, and the banks they oversee, to stem the credit crisis increasingly resemble a tug-of-war between both sides.
At issue are the mark-to-market accounting rules governing bank holdings of tradable securities, including such complex and illiquid instruments as asset-backed securities and collateralized debt obligations backed by subprime mortgages.
The Financial Stability Forum, a group of regulators and central bankers led by Bank of Italy governor Mario Draghi, presented a package of recommended reforms to the Group of Seven in Washington last month. The proposals called for increased capital requirements for structured products and off-balance-sheet activities, improved liquidity risk management and, crucially, greater disclosure by banks of their risk positions and methods for valuing securities for which there is now little or no market.
But the ink was barely dry on the report when several top bankers lobbied the G-7 Finance ministers and central bankers directly to give banks greater leeway in valuing illiquid securities. The bankers, led by Deutsche Bank CEO Josef Ackermann, argued that today’s negative market psychology and lack of liquidity have depressed the observable prices of many securities to levels well below their real worth. In such circumstances, they say, enforcing strict accounting rules will merely contribute to a downward spiral in credit markets.
“We have a divergence between mark-to-market valuation of assets and the underlying value of assets,” says Charles Dallara, managing director of the Institute of International Finance, a research and lobbying body for major international banks. The organization is talking to a number of leading regulators about ways to come up with clear and consistent criteria for allowing banks to deviate from mark-to-market rules, he says. Dallara insists that banks aren’t seeking special treatment and agrees that any changes must be accompanied by full disclosure of banks’ positions. “We have to be very careful not to appear to be allowing banks not to recognize losses,” he notes.
The lobbying effort met with a blunt rejection from one leading regulator. Jaime Caruana, head of the monetary and capital markets department of the International Monetary Fund, acknowledges the difficulty of valuing positions but says complaints about the ABX, which are indexes of asset-backed securities that many banks say undervalue the real worth of many securities, aren’t justified. “If somebody thought they were crazy prices, they would be buying,” he tells Institutional Investor. The IMF used the ABX indexes to come up with its estimate last month that losses on U.S. mortgages and mortgage-backed securities would total $565 billion and that the ultimate cost of the crisis, including such areas as consumer credit and commercial real estate, would hit $945 billion.
Putting off the recognition of losses would prolong uncertainty and delay a recovery from the crisis, Caruana says. “I don’t think that now is the time for that kind of forbearance. You certainly will not be improving things by that kind of approach.”
The banks appear to be winning some converts to their cause, however. The Bank of England said in its Financial Stability Report last month that ABX indexes were implying that subprime mortgages securitized in the second half of 2006 had a 76 percent risk of default and a loss-given-default rate of 38 percent. Such values “are likely to overstate significantly the losses that will ultimately be felt by the financial system,” it said.
