Goldman Sachs and Morgan Stanley are considering abandoning mark-to-market accounting (writing down asset value to reflect current estimates), according to the Wall Street Journal. That would be an amazing climbdown for the two Wall Street firms. After all, they have long made a virtue of taking their lumps early.
Goldman chief executive Lloyd Blankfein, especially, has long argued that using daily price fluctuations to value the bank’s assets is a crucial risk-management tool. Thankfully, they might only make the change for one small part of their balance sheets. But, it shows just how deep the pain of the financial crisis has penetrated.
The change would usher in what’s called historical cost accounting, which allows banks to take losses only when a borrower defaults. But, it’s not fear of taking large losses that’s an issue. The switch Goldman and Morgan Stanley are considering would only apply to undrawn lines of credit to companies with investment-grade credit ratings.
What’s more, it would also probably only be instituted for those loan commitments that the banks expected to keep, rather than sell or refinance. Everything from leveraged loan commitments to term loans to equity investments to highly structured mortgage securities would still be marked to market every day.
That leaves a maximum of $55 billion of assets at Morgan Stanley and around $20 billion at Goldman that could be in for the new accounting treatment. Assume only a third of these fit all the criteria for historical cost accounting. These are usually worth less than face value as soon as they are made, but rarely fall more than a per cent or two outside of a crisis — when they might be drawn anyway and need to be marked.
By avoiding mark-to-market on the commitments, a one per cent drop would add, after tax, a combined $165 million to the two firms’ annual earnings. It may not be a whopping amount but every dollar counts these days. That makes the accounting change look more like an exercise in profit enhancement. And, expanding it to other loans would add other costs, like setting aside loan loss reserves. As long as the shift stays at the margins, it’s not terrible policy, but investors should keep an eye on the slippery slope.