May 2011
Transaction and Regulatory Committee
Distressed Property Task Force
Federal Committee
This material is for discussion purposes only and has not been approved by the Transaction and Regulatory Committee, Federal Committee, Executive Committee or the Board of Directors.
Issue:
Should C.A.R., in conjunction with NAR, “SPONSOR” legislation that advocates for lenders and investors to utilize mark-to-market accounting for mortgage backed assets?
Action:
Optional
Options:
1. “SUPPORT” a return to full mark-to-market accounting.
2. “SUPPORT” a return to mark-to-market accounting in a limited basis; such as for properties that have been in default long enough to constitute little chance of avoiding a short sale, deed-in-lieu, or foreclosure.
3. “OPPOSE” a return of mark-to-market accounting for assets that are likely to be held until full maturity, such as mortgages.
4. Take no action
Status/Summary
Transaction and Regulatory Motion from Winter 2011 Meetings:
That C.A.R., in conjunction with NAR, propose legislation to improve and ease the short sale process, including a provision to require servicers and lenders to utilize “mark to market” accounting for properties subject to a notice of default.
C.A.R.’s Federal Committee voted not to approve the Transaction and Regulatory Committee’s motion.
The C.A.R. Executive Committee assigned the Distressed Properties Task Force with the responsibility of reviewing, deliberating and proposing policy direction for the Association on the issue of Mark-to-Market accounting.
Background:
Mark-to-Market:
Mark-to-market is an accounting term that means assets on a company’s balance sheet are valued at what they can currently be sold for at that time. For example, if an institution was holding onto a bond that they could sell for $1 billion right now, then under mark-to-market they would show that bond as being worth $1 billion. Many people believe this is the most accurate representation of the financial health of a business. The argument goes that if an investor or depositor wants to know the financial health of a company, it doesn’t matter what the price was for the assets of the company when they purchased them; but the current price of the assets compared to the current liabilities shows the true financial health of the company.
This accounting was effectively suspended in early 2009 as a response to the financial crisis. The concern was that mart-to-market was creating a “death spiral” causing many companies to become insolvent when they really weren’t. As markets froze, businesses had difficulty trying to price assets as investors began refusing to purchase any investments. This would require a business to offer their assets at reduced prices to entice investors. This reduced price, the price of the asset at the current value, began to cripple balance sheets of financial institutions. Their assets were being reduced compared to their outstanding debt forcing many institutions to head towards insolvency.
Over the summer of 2010, the Financial Accounting Standards Board (FASB) proposed moving back to a mark-to-market accounting (FASB uses the term “fair value”). After more than 2,800 letters commenting on their proposal, FASB came out with a recommendation that backed off of using mark-to-market for loans and any other assets originated or purchased for long-term cash-flow. The new proposal states “that financial assets managed through a lending or customer financing activity that an entity holds for the collection of contractual cash flows should be measured at amortized costs.” Amortized costs being the method currently utilized. This is often used for assets that are intended to be held until full maturity.
REALTORS® Impact:
While not overly concerned with the larger picture of accounting standards for lending and financial institutions, the idea has been put forward that one way to force lenders and investors to move distressed properties is by forcing them to use mark-to-market accounting. The theory is that this would force them to unload many non-performing properties in order to clean up their balance sheets.
Outlook:
FASB just released their proposal earlier this year and it remains unclear whether or not they will make this a final or if they will again open it for comment. A question that remains unanswered is how to classify assets under the amortized cost category that the entity subsequently sells? This is not covered under this rule and has been delegated to the FASB staff to come up with an answer or proposal at a later date.
Support:
Supporters of mark-to-market say:
• While imperfect, mark-to-market accounting does allow investors and depositors of banks and financial institutions to know their health at any given time.
• Without mark-to-market there is really no way to know exactly what the financial health is of an institution. They could hide worthless assets as long as they would like.
• The current accounting method has allowed lenders to overinflate their profits by not having to realize certain losses.
• Forcing mark-to-market would prohibit lenders ability to hide non-performing assets and force them to begin moving these properties off their balance sheets.
Opposition:
Opponents of mark-to-market say:
• Mark-to-market is an accounting method better utilized for assets that are not intended to be held until maturity, such as stocks.
• Many lenders, including Bank of America and Wells Fargo already report the fair value of their loans in the footnotes of their quarterly reports to regulators.
• Mark-to-market, as well intentioned as it may be, is simply not a viable accounting option for mortgage backed securities and is likely to lead to more bubbles and collapses than a steady growth in the economy.
C.A.R. Policy:
C.A.R. has no policy on mark-to-market accounting.
NAR Policy:
NAR was concerned that the 2010 FASB accounting proposal to return to mark-to-market would have dramatically reduced the availability of capital for real estate, especially in light of the residential and commercial real estate liquidity crisis. NAR called for more flexible mark-to-market accounting rules and encouraged the use of other more practical valuation tools to assist with valuing assets in illiquid markets.
Should C.A.R., in conjunction with NAR, “SPONSOR” legislation that advocates for lenders and investors to utilize mark-to-market accounting for mortgage backed assets?
Additional Links:
Mark-to-Market Explanation: http://www.youtube.com/watch?v=1jA6vCu8k_w
Buffett on Mark-to-Market: http://www.youtube.com/watch?v=xyKH19tWXn0&feature=related
