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15 Years ago Charles Bowsher’s Warning was Ignored. Let’s Not Make the Same Mistake Today

April 5th, 2009 by selise

Note: This is part 5 of a series on the (mostly) legislative history of financial deregulation that has contributed to our current financial and economic crisis. For the entire series, including the timeline (where most of the reference links are), see the Financial Regulation Timeline page. Please use the comments to contribute links and other information. Thanks, selise.

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Fifteen years ago Charles Bowsher warned us about unregulated OTC derivatives. Now he’s warning us about mark-to-myth accounting rule changes.

We now know just how dangerous unregulated OTC derivatives like credit default swaps are to the global financial system. But 15 years ago – 4 years before Brooksley Born’s warning and more than 6 years before the CFMA 2000 was passed in a bipartisan rejection of regulation, Charles Bowsher, as Comptroller General of the United States, sounded the warning in the GAO report, FINANCIAL DERIVATIVES Actions Needed to protect the Financial System and in testimony before Congress.

From his 1994 GAO report:

Much OTC derivatives activity in the United States is concentrated among 15 major U.S. dealers that are extensively linked to one another, end-users, and the exchange-traded markets. This combination of global involvement, concentration, and linkages means that the sudden failure or abrupt withdrawal from trading of any of these large dealers could cause liquidity problems in the markets and could also pose risks to the others, including federally insured banks and the financial system as a whole.

From his 1994 testimony before Congress:

Given the gaps and weaknesses that impede regulatory preparedness for dealing with a financial crisis associated with derivatives, we recommend that Congress require federal regulation of the safety and soundness of all major U.S. OTC derivatives dealers. The immediate need is for Congress to bring the currently unregulated OTC derivatives activities of securities and insurance firm affiliates under the purview of one or more of the existing federal financial regulators and to ensure that derivatives regulation is consistent and comprehensive across regulatory agencies. We also recommend that the financial regulators take specific actions to improve their capabilities to oversee OTC activities and to anticipate or respond to any financial crisis involving derivatives.

Now Charles Bowsher is sounding another warning, this time about accounting rule changes that have replaced mark-to-market with mark-to-myth.

FHLB Executive Who Left Cites Securities Valuations

Charles Bowsher said he resigned last month as chairman of the Federal Home Loan Bank system’s Office of Finance because he wasn’t comfortable with the way the banks value their mortgage securities.

"I decided I didn’t have confidence in the financial statements," Mr. Bowsher said in an interview, confirming remarks that previously appeared in a Bloomberg News article. Mr. Bowsher, a former partner at the accounting firm Arthur Andersen, said he believes financial companies generally, not just the home-loan banks, have too much discretion in valuing assets such as mortgage securities. "They put a lot of assumptions in there," he said.

The Office of Finance coordinates debt sales by the 12 regional home-loan banks and compiles combined financial results for them. But the individual banks and their auditors are responsible for accounting policies.

Tyler Durden, guest posting at naked capitalism, explains what this means in a must read post, FHLB Chairman Disgusted With FASB Accounting Alchemy, Quits

When the man in charge of the second largest borrower in the U.S. is willing to lose his job due to his discomfort with the FASB’s shift in accounting rules, you can bet that the tragic fallout of all the "market buoying" recent events is only a matter of time.

…one of the men who knows the ins and outs of the financials of banks involved in the mortgage crisis more intimately than even Bernanke and Geithner, let alone Obama, is saying that the newly implemented changes by the FASB will throw the whole system into tailspin and he want none of it.

If this isn’t the most damning condemnation of the Kool Aid the administration, the Treasury, the Fed, the FASB, the FDIC, and all the other alphabet soups are trying to make the common U.S. citizen drink and have seconds, then nothing else possibly could be…. of course until Bowsher is proven right and everything collapses into the smoldering heap of defaulted MBS still marked at par on various liquidating banks’ balance sheets…

Oh and yes, let’s hold a moment of silence for Lehman which held billions of mortgage backed securities that it too was "holding until maturity." Well, Lehman is no more, and all these securities now trade, in the form of the company’s general unsecured claims, at the generous price of 12 cents on the dollar… Furthermore, one can’t say the market is illiquid – the bid-ask spread is only 1 cent. And as there are over $150 billion of these claims floating around, one can’t say the market is in any way limited from a price discovery standpoint.

Maybe if more honest leaders follow in Bowsher’s unique example, the general population will finally start seeing though the everyday lies and misinformation coming out of D.C.

One last note on where the pressure came for FASB to change it’s rules – that would be our Democratic majority Congress, led by Barney Frank (for background see ubetchaiam’s diary, Mark to Whatever You Think is Right)

x-posted at oxdown