The former president of the Commercial Mortgage Securities Association (CMSA) told a congressional subcommittee today that the government’s mark-to-market rules are imposing hardship on the $3.4 trillion commercial mortgage market at a time when participants already are overburdened by the distressed economy and scarcity of credit.
Turmoil in the financial markets and the economic downturn have brought the commercial mortgage-backed securities (CMBS) market to a standstill, in contrast to 2007, when CMBS powered the market with $240 billion in U.S. issuance — nearly 50% of all commercial lending.
Lee Cotton, former president of the CMSA, testified before the House Subcommittee on Capital Markets, Insurance, and Government-Sponsored Enterprises. In 2008, CMBS financing plunged to less than $13 billion in U.S. issuance, despite strong credit performance and high borrower demand, Cotton said.
“While CMBS market participants are struggling with the paralyzing effect of the credit freeze, they are simultaneously faced with the highly problematic and related effect that the FVA (fair value accounting) standard is having on their balance sheets, which must be addressed before new lending can occur,” Cotton said.
The CMBS industry supports the fair value standard, Cotton said, but it takes issue with the way its mark-to-market rule has been applied. Mark-to-market accounting requires valuing assets at current market values, under the rules set by the Financial Accounting Standards Board (FASB). The Securities and Exchange Commission has tasked the board with setting standards for financial reporting.
“CMSA supports FVA, and we believe it works when the markets are functioning and there is not extreme volatility or disruption in those markets,” Cotton said. “However, CMSA strongly believes that the FVA standard, as currently implemented, has negative, unintended consequences when the markets are illiquid and/or highly volatile.” The CMBS industry wants federal policymakers to adjust the guidelines for applying mark-to-market rules in nonfunctioning markets.
“We have found that while the FVA standard works on paper, it is not working in practice,” Cotton said. “Market illiquidity and volatility result in distorted data being used to value assets, despite the performance and cash flow that investors holding these assets are receiving.”
The mark-to-market rules have prompted a groundswell of complaints from commercial real estate investors and lenders who say that the accounting policy has required devaluation of performing assets and forced companies to value the assets at fire-sale prices.
It appears that the federal government is willing to not only listen to the complaints, but it may also be prepared to adjust the way the rules are applied. That could offer relief to CMBS borrowers and to the capital markets, which play a crucial role in revving up the economy with new loans, enabling financial and property transactions to occur.
This week, Federal Reserve Chairman Ben Bernanke indicated that while he supports the fair value standards, he was open to fine-tuning the mark-to-market requirements. "We need to provide more guidance to financial institutions about what are reasonable ways to address the valuation of assets that are traded at all in highly problematic markets," Bernanke said Tuesday.
An SEC official, James Kroeker, acting chief accountant, testified that the commission supports FASB as its independent accounting standards setter, but he says the independent board also needs to be flexible when it comes to investors’ problems.
“The FASB must be responsive to the needs of capital market participants, particularly investors,” Kroeker said. “We believe that responsiveness is enhanced by collaboration among investors, preparers, auditors, regulators and independent accounting standard setters, and we will take all prudent actions to encourage such collaboration.”
Congressman Paul Kanjorski (D-Pa.), chairman of the subcommittee holding the hearing, says the mark-to-market policy has forced some companies to write down billions of dollars worth of assets, which has caused ripple effects elsewhere in the marketplace.
Credit-challenged markets such as the current one make it difficult to place a value on assets, Kanjorski says. But while many companies seek relief, investors across several industries need accurate information.
“I want to find a way — within the existing independent standard-setting structure — to still provide investors with the information needed to make effective decisions without continuing to impose undue burdens on financial institutions,” Kanjorski emphasizes.
A number of influential auditing and consumer groups, including the Consumer Federation of America and the Council of Institutional Investors, oppose suspending fair value accounting requirements of the FASB 157 mark-to-market rule, saying that dropping the rule would harm the credibility of the national standards and would not be in the public interest.
Cynthia Fornelli, executive director of the Center for Audit Quality, whose governing board includes leaders from the auditing and accounting professions, as well as investors and academics, warned that while the rules can be improved, tampering with the fair value standard could actually harm the nation’s economic health.
“Suspending fair value accounting or FAS 157 would eliminate an important tool for making transparent the economic health of publicly traded companies,” she said. Investors would lose confidence in the reliability and transparency of financial reporting, she said. “Changing accounting standards to remove much‐needed transparency would likely undermine investor confidence and could prolong the current crisis.”
During the savings and loan crisis in the 1980s, financial statements prepared for regulators obscured the declining state of certain financial institutions’ assets and liabilities, Fornelli added. “In any of these institutions that later failed, the resulting damage to the federal deposit insurance funds was much larger than it otherwise would have been had fair value principles been required.”
Regulators should take steps to improve the principles’ application, she said. “Investors need to know the current values of loans and securities in order to make rational investment decisions; regulators need to know the current values of loans and securities in order to make rational policy decisions.”