Please ensure Javascript is enabled for purposes of website accessibility

Goldman Sachs Takes the High Ground

By Tom Hutchinson – Updated Nov 11, 2016 at 5:28PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

It threatens to leave an international group over a proposed rule change for accounting.

It's rare when someone rises above the fray to do the right thing.

Last week, Goldman Sachs (NYSE:GS) said it might drop out of the Institute of International Finance (IIF), the leading international banking lobby, over a dispute about accounting standards. (This is according the Financial Times, which has since published the IIF’s clarified position). On the surface, it seems like a boring technical squabble, but it is anything but.

Why leave such a swell group?
Since January, the Financial Accounting Standards Board (FASB) has dictated that companies value their illiquid assets at fair market value instead of historic value.

Fair market value for derivatives holdings linked to subprime mortgages is what the market would currently pay for these securities, and historic value is where these securities have traded in the past. In this credit crisis, fair market value for such securities is lower than historic value would be. The new accounting rule, Statement of Financial Accounting Standards (SFAS) 157, has had a dramatic impact on large banks.

Forcing banks to value their illiquid securities at the lower market value has led to billions in additional write-offs. Just look at the latest quarterly numbers from Citigroup (NYSE:C), UBS (NYSE:UBS), Merrill Lynch (NYSE:MER), or Wachovia (NYSE:WB). To try to raise capital to replace these losses and shore up reserves, many banks have had to cut dividends, pull back on loan activity, and issue additional shares that dilute existing holdings.

Couldn't banks use a break?
The IIF, most likely fed up with astronomical losses and the painful consequences, has proposed changing the rules and allowing banks to use historical and not market prices to value illiquid assets. Goldman then threatened to quit the group, calling the proposed changes "Alice-in-Wonderland Accounting." Morgan Stanley (NYSE:MS) also objected to the proposal.

A case can be made for using historic value. Market value may force banks to take unrealistically large write-offs. Given today's credit crisis and the ensuing lack of appetite for mortgage derivatives, current market values might be overly depressed. These losses are unrealized and only become realized if and when the securities are actually sold. Perhaps the market value of these derivatives will improve when the credit crisis wanes. Banks may never actually realize these losses that are killing them in the near term and might be inviting future regulatory scrutiny. So, what's wrong with giving banks a break?

Don't let them get away with it
In this Fool's opinion, market value provides a more honest assessment of a bank's present situation. Maybe the securities in question will gain value in the future, but that's speculation. Also, market value gives banks a uniform standard by which they can be compared. By sidestepping the true current value of illiquid securities, banks are using a slick maneuver to get themselves off the hook. Didn't slick maneuvers get banks into this mess in the first place? Have they learned nothing?

Although the IIF proposed these changes as optional, Goldman threatened to leave the group. Perhaps Goldman doesn't want to be part of a group that would maneuver itself out of trouble. Goldman has forged a reputation as an investment bank that is a notch better and a breed apart from the others. If it doesn't distinguish itself from the losers by doing things better, it'll be just another loser.

For related Foolishness:

None

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

The Goldman Sachs Group, Inc. Stock Quote
The Goldman Sachs Group, Inc.
GS
$301.97 (-3.50%) $-10.95
Morgan Stanley Stock Quote
Morgan Stanley
MS
$81.51 (-3.85%) $-3.26
Citigroup Inc. Stock Quote
Citigroup Inc.
C
$44.26 (-2.90%) $-1.32
UBS Group AG Stock Quote
UBS Group AG
UBS
$14.91 (-3.81%) $0.59

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
329%
 
S&P 500 Returns
106%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 09/24/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.