Is there still anyone who wants the opinion of Robert Rubin on anything having to do with banking or finance? We assume his opinions on the finer restaurants in New York City are spot on and he probably knows a good tailor, but when it comes to financial matters, we had assumed that the value of his advice would have been written down down to zero.
Rubin served as senior counselor at Citigroup from 1999 until earlier this month, when he was more or less forced to quit the job that had garnered him tens of millions of dollars. Exactly what he did as senior counselor was never quite clear. We imagine his connections around the world, connections solidified when he was the Treasury Secretary, provided some value to Citi. For all we know, he might have been responsible for enough investment banking fees to make him worth those millions.
But there was the assumption around town that Rubin was one of the wise old men of Wall Street and was actually providing guidance to Citi’s managers and its board of directors. And Rubin did little to temper that assumption. If he was providing advice, it must have been wrong or ignored.
Now Rubin is back! Last night he spoke at the 92nd St Y and delivered his opinion about mark-to-market accounting. That’s the accounting practice, also known as fair value accounting, that says companies must value assets at their market value.
Banks were happy with mark-to-market accounting when it allowed them to show gains by simply holding onto appreciating assets. But they hate it now that the market value of so many assets has dropped. Rubin himself explains how this dynamic played out in his brain.
“I spent my whole life at Goldman Sachs believing in mark-to-market accounting, and having said that, if you look at the experience from the last two years, I think mark-to-market accounting has led to terrible vicious cycles in asset prices,” Rubin said according to Bloomberg.
The argument against mark-to-market is that it forces companies to take write-downs on assets they don’t otherwise have to sell. They claim that the market is underpricing the assets, perhaps because of a lack of liquidity. Rubin wants to move to something called ‘reserve accounting.’
“Mark-to-market accounting has done a great deal of damage,” Bloomberg reports Rubin said. “For a lot of financial institutions we should move to something that is more similar to reserve accounting. That will be a very controversial matter.”
What’s reserve accounting? It would allow banks to carry loans and mortgage backed securities at cost—either face value or what they paid for them. If the loans were viewed as troubled by the bank, it would have to reserve against the potential loss.
At the heart of reserve accounting is a confidence that banks are pretty good at figuring out how much they need to reserve against losses. Does anyone who isn’t Robert Rubin really share this confidence? Banks have proven that they were tremendously bad at estimating loan losses. That’s a huge part of why we’re in this mess.
Rubin’s plea for reserve accounting amounts to a claim that bankers are smarter than markets when it comes to figuring out value. This might be true here and there, when information is scarce or confused so that arbitrage opportunities are created. But you don’t have to be a hard-core efficient market type to wonder if this isn’t just wishful thinking on Rubin’s part.
How could Rubin think he’s smarter than the markets? Well, for one thing, he’s smarter than most people. And the markets are made up of lots of people who aren’t as smart as him. What’s more, historical asset prices and correlations suggest that the market is ‘dislocated’ or ‘misbehaving.’ The models designed by people almost as smart as Rubin say that the toxic assets must be worth more than current prices suggest. It doesn’t seem to have occurred to him that the models and correlations might not be as durable as he thought. Which, actually, isn’t very smart at all.