Crisis Talk - The World Bank Group

Today in China: Panda Put or Cliff Dive?

In light of yesterday's 6 percent drop in the Shanghai composite, there is increasing speculation about the sustainability of the buildup in Chinese equity markets (see recent post).

China’s stimulus efforts, led by increased bank lending, have caused the economy to look more and more frothy:

Is there a China bubble brewing?  If so, will the Chinese government intervene to avoid a crash (the panda put option)? Or are we in for a sharp correction?  Let's see where the market pundits stand:

The Great Mark-to-Market Debate

The leaders of the Group of 20 (G20) recently called on the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) to improve financial reporting standards for calculating the market value of assets in illiquid markets. The debate over mark-to-market accounting, which is a subset of fair-value accounting, and its role in the financial crisis, made its way to Congress during the first half of March 2009. The concern is that banks will not incur the losses booked per mark-to-market accounting as asset values recover over time from today’s clearance sale prices.

The mark-to-market concept may sound trivial, especially when compared to a $787 billion rescue plan, but getting it right would be a significant step toward addressing the causes of the credit crisis. The main aim is to simplify the complexity of financial reporting and off-balance sheet financing and to make progress towards a single set of high quality global accounting standards. 

In a forthcoming paper in the Journal of Economic Policy Reform, I discuss the costs of mark-to-market valuation within the US 2009 (Bailout) Emergency Economic Stabilization Act (EESA). The paper highlights how mark-to-market valuation standards influenced financial institutions, explains why mark-to-market policy suspension proponents can support EESA, and explains how the FASB and the SEC can count on EESA while assessing the need for mark-to-market valuation policy.

G20 Update: Best Protestor of All?

 

(Thanks to Rob Kahn for the pointer.)

Share Prices and Accounting Reclassifications

Editor's Note: The following post is a joint contribution by Costas Stephanou and Haocong Ren.

As some may recall, Deutsche Bank (DB) took advantage of the change in IFRS rules (under pressure from the EU Commission) and reclassified almost Euro 25 bn. of hard-to-value (toxic?) securities from its available-for-sale portfolio to the held-to-maturity portfolio in October 2008. This allowed it to improve its reported net income for 2008Q3 by more than Euro 500 million and to report a quarterly profit, as opposed to the loss that analysts were expecting. Its stock price shot up 15% on the day of the announcement (October 30, 2008) vs. 1.2% for the relevant benchmark index (S&P 500 financials), and similar behavior could be observed for its 5-year CDS spread vis-a-vis the relevant benchmark (iTraxx Europe senior financials).

This jump in the share price washes away (based on a preliminary statistical analysis - see the attached Excel file) when looking at the evolution over a longer time period vis-a-vis the benchmark. It may also be due to a perceived market relief that DB's reported tier one capital adequacy ratio (partly as a result of the accounting changes) exceeded 10% and therefore DB had no apparent need for more capital raising  that would lead to shareholder dilution. However, it is instructive to see how - at least anecdotally - accounting rules have real effects on share prices since DB's accounting reclassifications represented the main reason why analyst expectations were exceeded, as was pointed out explicitly in the financial press. (See here, here, here, here, and here.) 

G20 Summit: Unprecedented Focus on Financial Reporting

Financial accounting and reporting were a central issue at the November 15 meeting of G-20 leaders plus the leaders of Netherlands and Spain. The Summit’s Declaration sets the stage for several important reforms, some of which are already in progress.

First, the summit leaders agreed on “enhancing required disclosure on complex financial products and ensuring complete and accurate disclosure by firms of their financial conditions….” This widely-heard complaint in the immediate aftermath of the crisis is something that securities regulators and accounting standard-setters have already begun addressing. For instance, in September 2008, the SEC sent a letter to certain public companies regarding disclosure and the application of FAS 157. Also, last month, the IASB has issued a proposal for improvements to financial instruments disclosures. Much work remains to be done on this front but a strong consensus exists.

Second, they agreed to “strengthen regulatory regimes, prudential oversight, and risk management….” This is a potentially more difficult issue insofar as financial regulators and accounting standard-setters do not necessarily see eye to eye on all accounting issues. Many in the accounting world are wary of possible interference from prudential rules with transparent financial reporting. One traditional sticking point has been fair value accounting, a major attribute of modern financial reporting, which has been blamed by some for its pro-cyclical effects.

The fact that the leaders of the world’s 22 largest economies devoted so much attention to accounting issues in their discussions is unprecedented and should be applauded. Indeed, strengthening prudential supervision and market discipline, two building blocks of the international financial architecture, will require bold action backed by strong political commitment at the highest level, and much closer cooperation between all key decision makers on the world stage. The Declaration sets forth an ambitious, fairly detailed and prescriptive Action Plan to Implement Principles for Reform, which is likely to keep policymakers, financial sector regulators and accounting standard-setters around the world very busy over the coming months.

Mexico adopts IFRS: a timely decision

November 11, 2008 will be a landmark in Mexico's accounting history. On Tuesday, the Securities and Banking Commission (CNBV) announced that it was requiring listed companies to apply International Financial Reporting Standards (IFRS) starting in 2012.

Some may question the timing of the decision considering that IFRS strongly emphasizes the use of fair value accounting, and the latter has been heavily criticized since the current financial crisis erupted. One should note however that the most vocal critics of fair value accounting have been the bankers, and the CNBVs' decision will not affect Mexican financial institutions.