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Behind Schwarzman Spat With Wasserstein Lies Rule 115 (Update1)

By Ian Katz

Dec. 8 (Bloomberg) -- An argument between two Wall Street titans seated in director’s chairs at Per Se restaurant in New York in October has escalated into a fight over an obscure accounting rule known as Statement No. 115.

Five weeks ago the dispute was over so-called fair-value accounting, which requires companies to record assets every quarter to reflect market value. In one chair was Blackstone Group LP Chairman Stephen Schwarzman, who said the standard had aggravated the worst financial crisis since the Great Depression. In the other was Lazard Ltd. Chairman Bruce Wasserstein, who said the rule gives investors an honest look at corporate earnings.

Now banks, which have been unsuccessful in getting regulators to revamp fair-value, also known as mark-to-market, are trying to win revisions to another U.S. Financial Accounting Standards Board requirement that could preserve billions of dollars of their capital.

“Financial institutions, which have been woefully incompetent in running their own firms, are now trying to avoid providing investors with accurate numbers depicting the large losses they have suffered under their mismanagement,” said Lynn Turner, the Securities and Exchange Commission’s former chief accountant, in an interview.

The Financial Services Roundtable, whose members include New York-based Citigroup Inc. and Bank of America Corp. of Charlotte, North Carolina, are proposing using Statement No. 115, which applies to so-called impaired debt and equity, for some securities that now fall under the fair-value rule.

‘Downward Spiral’

In a Nov. 12 letter to the SEC, Robert Traficanti, Citigroup’s head of accounting policy, gave an example of mortgage-backed securities the bank owns and said the rule change would reduce a third-quarter charge to earnings to $19.2 million from $76.2 million. The proposed switch “is a much better reflection of the losses we expect to incur,” he wrote.

By using standard 115, banks could take into account cash generated from underlying assets such as mortgages and not rely on a market price dictated by the fair-value rule.

Moving to the impaired debt and equity standard would help “stop the downward spiral caused by the inability of ivory tower accounting rules to recognize the economic value of an asset,” Scott Talbott, the Washington-based roundtable’s chief lobbyist, said in an interview.

Michael Williams, research director for Gradient Analytics Inc. in Scottsdale, Arizona, says the change could allow banks to avoid raising capital to comply with federal regulations.

For banks, Williams said, “the biggest worry they have is regulatory capital.”

Fair-Value Review

SEC Deputy Chief Accountant James Kroeker said the agency has been urged to clarify the impairment rules. “We’ve heard from investors that there’s room for improvement,” Kroeker told reporters at a conference in New York last month.

Kroeker is leading a study on fair value that the SEC is required to conduct under terms of the $700 billion federal financial-rescue package enacted in October. The SEC must submit a written report to Congress by Jan. 2 that evaluates how the rule can be improved and whether it has caused banks to fail.

Preliminary findings from the study show that investors want the SEC to issue “guidance” to clarify fair-value, SEC Chairman Christopher Cox said in a speech in Washington today.

“Most investors and many others agree that fair-value is a meaningful and transparent measure of investment for financial- reporting purposes,” Cox said at an American Institute of Certified Public Accountants conference. “The work that we’ve already done suggests that the accounting standard-setters could improve upon” rules for impaired securities, he said.

Schwarzman’s Lament

The SEC, which can overrule FASB, has declined to overhaul the fair-value rule, known as Statement No. 157, releasing clarifications in September that didn’t satisfy industry groups. The global credit crunch transformed the rule, which took effect a year ago, into a mainstream economic topic.

“Historians will look back some day and say that the government drove companies into bankruptcy by creating artificial losses,” former House Speaker Newt Gingrich, 65, who led the 1994 Republican takeover of Congress, said in a Bloomberg interview in October.

Those arguing for change include some of the companies suffering the most since the subprime-mortgage crisis began last year, including Citigroup and American International Group Inc. Critics, who say the fair-value rule doesn’t work when there are no buyers for toxic assets, include the 61-year-old Schwarzman, whose New York-based Blackstone manages the world’s largest private-equity fund and whose shares have fallen 72 percent this year in New York Stock Exchange composite trading.

‘Major Contributor’

The rule “and the way it’s been implemented has been a major contributor to the financial crisis,” Schwarzman said at the Oct. 30 discussion hosted by Fortune magazine at Per Se.

Wasserstein, 60, who has a better track record this year with Lazard declining 37 percent in NYSE composite trading, took the opposite position.

“Accounting has now become an exercise in creative fiction,” he said. “Saying assets are worth a lot doesn’t make them worth a lot.”

Wasserstein and Schwarzman both declined to comment.

Democratic legislators are less eager to overhaul fair-value than Republicans. In a September letter, 65 House lawmakers urged SEC Chairman Cox to suspend the rule; only seven were Democrats.

Two of Obama’s closest economic advisers, former Treasury Secretary Lawrence Summers and former Federal Reserve Chairman Paul Volcker, have expressed support for fair-value accounting. So have Fed Chairman Ben S. Bernanke and Treasury Secretary Henry Paulson, who said on Nov. 20 that he knows of “no better accounting method,” even as he welcomed “steps to review and modify its implementation during severe market stress.”

Models Hindered

Private-equity executives, including Schwarzman, say mark- to-market accounting unfairly forces them to value holdings even if they have no intention of selling them at that time, hindering the business model of fixing up companies and disposing of them years later for a profit.

Brian Wesbury, chief economist at First Trust Advisors LP in Lisle, Illinois, compared the idea of forcing banks to price their assets now to a homeowner in California having to sell his house at the moment a fire is at his doorstep.

“If the bank knocked on your door and forced you to mark to market at that moment, you’d be bankrupt,” Wesbury said.

Citigroup Senior Vice Chairman William Rhodes and Deutsche Bank AG Chief Executive Officer Josef Ackermann are also fair- value critics. The two men, speaking in October in Washington on behalf of the Institute of International Finance, a global association of financial institutions, said the rule needs a review because it doesn’t work in illiquid markets.

Sour Grapes

Fair-value’s fans portray the complaints as sour grapes by banks that don’t want to admit how bad their subprime investments were.

Blaming the rule for the credit crisis “is a lot like going to a doctor for a diagnosis and then blaming him for telling you that you are sick,” JPMorgan Chase & Co. analyst Dane Mott wrote in a September report.

U.S. companies have used fair-value accounting since an earlier FASB rule took effect in 1993, Mott said at an SEC conference in November, and the newer rule simply defines the method and sets up a framework for how to implement it.

Matthew Schroeder, managing director for accounting policy at Goldman Sachs Group Inc., is another fair-value advocate. “For us, fair value is the oxygen of the firm,” he told the SEC in July. “It’s part of our fabric. We follow a daily discipline of marking to market at our firm. It can be done.”

Link - http://www.bloomberg.com/apps/news?pid=20601109&sid=aGLHt9Kw7JNo&refer=home



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