An obvious political wind has been behind the move to IFRS in the US. Making things more pressing is the common thread of economic suffrage underway globally and the role of financial information – or the absence of it – littering the path to these troubles.

The proposed rule is extensive and has two principal discussion segments, followed by the codification of the amendments. The first segment covered in sections I thru III lays out a strategic view of the obstacles to adoption and potential benefits available if a series of “milestones” can be reached, to the agency’s satisfaction. The second segment discusses circumstances where limited early adoption of IFRS by select companies is foreseen, if it’s found to enhance comparability of financial information for US investors.

I will focus on the principal strategic points in the first discussion segment of the proposal. I believe the staff expresses its reservations about the convergence ever coming to bear, along with the gates that have to be gone through, in order to overcome those reservations. This segment of the rule covers nearly 50 pages, so I will carve it into a series of blogs.

I was struck by a tone within the proposal. It’s diplomatic in its delivery and just as suspect about the value of the change and the likelihood it can be pulled off in anything short of a decade. And even then, it’s not clear the staff believe it would be adopting a more focused and informative compendium of reporting rules that will advance the protection of investors. They want it proven, steadfastly.

The momentum behind a transition for US reporting to IFRS has mounted swiftly. But anyone in the rulemaking chain with history writing, interpreting or applying US GAAP and IFRS understands such a hurried shift is as dangerous as it is popular.

US GAAP and IFRS are languages for conveying accurate accounts of historical financial position and results of operations. While US financial reporting has truly grown cumbersome and at times irrelevant because it can ignore economic substance underlying business transactions in favor of matrix based solutions, it will not get better for merely having adopted another reporting language. Its flaws are concentrated in application & interpretation.

Things like conservatism and organizational interests overcome economics. IFRS will not change this. Other kinds of influential variables currently exist in every jurisdiction that has or would adopt IFRS as part of the “single global standard” movement. The standards can be the same but the variables influencing the application and interpretation are as broad as the politics of each jurisdiction (e.g. how difficult is it to gain consensus at a UN meeting on any matter of global interest?).

The proposed rule establishes its benchmarks early:

We believe that the benefits of moving towards a single set of globally accepted standards as a long-term objective for increased comparability of financial statements are attainable through the use of IFRS only if IFRS represents a single set of high-quality accounting standards, which is best accomplished through the use of IFRS as issued by the IASB. (p. 17).

…in determining whether to proceed with requiring the use of IFRS by U.S. issuers, the Commission will consider the extent to which IFRS as issued by the IASB is used globally, is applied consistently, and supports the assertion of IFRS as the single set of high-quality global accounting standards. (p. 18)

The staff are making it clear that until the self-interest of individual nations is sacrificed for consensus adoption of a single authoritative rulemaker governing IFRS’s development and interpretation (to the SEC’s liking), IFRS remains an interesting concept but don’t look for it in a US prospectus any time soon.

Insurers who take our money under the promise to cover our misfortunes have their crusted hands cupped and held up for some alms. It seems there was some trouble with their risk modeling. Their PC’s dropped a decimal place or two and now they can’t find the money we gave them.

Auto manufacturers who suffered from strategic deafness during the last two decades re: fuel efficiency standards, alternatively fueled vehicles and the drying up of the oil patch, ply the Treasury with a sour tale of frightful times ahead if they and their strategic autism are not allowed to board Henry’s Ark.

And the bankers count their recap funds as they look out the windows of Treasury at the poor lot below, shuffling in the cold, practicing their beggar’s sonata.

Where does all this get us? Somewhere after the “CHARGE” command was uttered and the Generals of the Treasury and Federal Reserve led the way into the fray, the compass was dropped. None of this amounts to a coherent strategy to assure the flow of capital and secure economic stability.

The very valuable asset-backed security exchange program has now been completely scrapped. An abbreviated alternative has been instituted under the bank recap approach which is doing nothing to get the capital into circulation.

The sage leader of JPM was quoted at a banking conference saying he expects the recession to be a far worse bane on the US than the “financial crisis”. He must not think the one begets the other. How does an economy grow when the rescued bankers’ fists are balled up with all the federal (taxpayer) money?

And what of foreclosure fix #999, where non-performing loans are reworked against a formula capping mortgage payments at 38% of income and reworking loan duration and rate to shoehorn things into a pinched fit? The guys that didn’t understand you can’t lend wildly into a decade of flat incomes still don’t realize all the king’s men can’t make their dead horse run.

Home values will continue to fall until they are at the level incomes can afford them. Since incomes are evaporating with job losses, that target keeps going lower. This means every $1 of federal (taxpayer) money that is borrowed by Treasury to support the delinquent mortgage holder relies on the mortgage holder to help pay the $1in taxes needed to fund the handout they get from Treasury. Where does that leave Treasury (and us) when the mortgage holder with the re-worked terms loses their job and means to pay under any terms?

An employment based stimulus spending program can be a beneficial idea (as opposed to $165 bln, $600/head check in the mail that was not). But the roads and bridges lens looks backward. We’ve transitioned to the understanding that we need to wean society off carbon production and roads and bridges are about promoting carbon consumption. Best to leave that at the maintenance level and in the state’s hands.

The US would be well served by directing Treasury level sums of funding toward building out two primary structural programs. First you build out the renewable energy platform. Put federal dollars to adding wind capacity (with a sincerely competent operations team that understands meteorology, site selection, grid support and land lease management) and strategically placed solar (i.e. within metropolitan hubs where it can both demonstrate what it can do and reduce the fossil fuel supply squeeze at choke points for natural gas and power).

The second element is building out public use facilities that establish the US’s infrastructure support for the anticipated effects of climate change. Enough has happened that there can be a consensus that climate change is occurring, for all but the staunchest dissent. Developing water storage and related transportation pipelines is the kind of thing you do to foresee the obvious and put it in place.

These kinds of actions use federal stimulus dollars to address known and serious threats to forward economic health. It also puts a firm net under our current economy through meaningful employment.

From a finance perspective, they can be cash cows for Uncle Sam. I’ve packaged wind farms for the private sector (merchant energy) into portfolios. When bundled with the inherent tax advantages (production tax credits and MACRS), they were wildly attractive and strongly bid for by large institutions. Or Uncle Sam can issue them directly from its portfolio. They pour off large cash and tax advantages for 10 years or more. Similar structural opportunities are abundant if DC will broaden its lens.

The US can simultaneously create significant employment and put a net under the economy for the long term. The projects’ outputs would pave the way for a transition to the often cited “energy independence” and build the kinds of public works that insure that climate change doesn’t blow up our metropolitan societies and economy. The US will not only recover their debt principal but earn a return for taxpayers that is enviable.

Using an improved and efficient RTC model, where federal funds are used to purchase the mbs’s (and foreclosures) at current market value (i.e. 15 or 20 cents on the dollar), you can then create a transitional marketplace where the mbs’s have genuine value, based on the amount of the security that is performing.

At the federal level, you establish a legitimate valuation model to first get selling price to the investor. This includes federal backing if the mbs goes below a performance level that is agreed to in the purchase contract (e.g. sell at 50 cents and feds guarantee all losses below 30 cents for 3 year period).

Sell value would be based on percentage of the security that is performing and estimate of any erosion in that performance. Sales have the benefit of taking place orderly because the US holds the instrument and takes the performing cash flow until buyers come forward at prices that are reasonable for a disposition process.

This approach seeks to unlock the value that exists within the current worthless value assigned to mbs’s. It’s a significant action because it takes hundreds of billions of dollars that are currently receiving a $0 value on balance sheets and reintroduces them as a viable source of cash flow to investors.

It’s getting “bailout” money from the asset you are bailing out. It does not use federal debt backed by taxpayer funds for other than bridge financing and it puts large, accretive money into circulation, while recovering the feds investment. You wind up getting a real 3 or 4 to 1 multiplier effect by taking a worthless asset off the balance sheet for 15 cents/dollar and getting it to produce cash flow in the economy at 50 cents/dollar or higher (as the market develops for mbs’s again).

The Feds/taxpayers will bear the risk of non-performing mbs’s whether they are left on the balance sheet at $0 or bought with the intention of creating a market for them. It makes good sense to actively get involved and make the market. It’s making lemonade from lemons.

Securitization is going to have to return in some form and work, prospectively, if there are going to be global markets. Packaging standards are going to have to be like food labeling and be well mapped to the underlying borrower and assets. Recourse risk will have to exist for those who package and label negligently or not in good faith.

Recap’s momentum had two drivers. First, Europe had already announced it and the US policy makers believed our banks would be at a competitive disadvantage without implementing the same program, from both the perceived stability of our banks as well as having huge new capital to invest with.

Second, there would be a favorable multiplier effect to the action. The historical bank lending-to-capital ratio of roughly 10-1 would put $2.5 trillion into economic circulation for only $250 billion of TARP funds (~ 1/3rd of appropriations) .

The trouble with this view is the banks are broken. It’s not reasonable to conclude the historical 10-1 leverage of capital can or will be implemented within the window of opportunity that exists for it to put a net under the US economy. Global invested funds are currently undergoing a contraction (not expansion), as money is pulled from all but the surest vehicles. Look to the exit of money from emerging markets for an example.

The recap approach also leaves the damaged financial instruments right where they were, on balance sheets with worthless valuations because no one will buy them. There is substantial performance occurring on many of the instruments but they cannot be sold because there are no willing buyers.

The principal reasons are further erosion of mbs performance is not estimable and the instruments are not accepted as collateral from counterparties. In both cases the markets are unable or unwilling to divine a genuine cash flow and risk based model for their valuation.

If left as they are, the mbs’s are likely to remain in this state in perpetuity. Global markets have finally begun to understand there is a severe contraction in demand underway and they don’t have any benchmark for charting forward demand for goods & services. From the standpoint of mbs’s, this means the underlying mortgages are at further risk of default as business protects its assets and earnings from lost revenues, through head count reductions, taking away borrowers means to pay.

With the recap model, we’ve just given a staggering sum of money to banks that could not properly manage what they already had and you bury hundreds of billions of dollars in value (mbs) as a worthless line item on the balance sheet.

In practice, the banks have earmarked the federal funds for capital preservation or talk of using the recap funds for acquisitions, which makes things worse. As Federal Reserve Chair Bernanke observed and I’ve blogged, we’re kidding ourselves if we allow a handful of banks to carry 50% or more of US deposits & loans.

That concentration is a bomb with a short fuse that has the capacity to bring greater trouble than what is transpiring currently. And you are allowing it in an industry that has twice undertaken catastrophic lending strategies in the last 20 years (S&L commercial real estate failure included).

It leaves you feeling the recap strategy is testifying that the risks to stability are expected to remain strong and consolidation is seen by policy makers as sandbags around depositors.

This graph is paired with the ubiquitous and equally unreliable forward price curve. “Everybody’s got one,” a risk VP said to me. “None are any good.” They’re less good now.

Commodities received gold rush valuations from price being squeezed by a charge of institutional money throwing itself at it under the guidance of many dubious models, absent important variables (i.e. systemic liquidity risk event, demand contraction).

The supply side was insistent that current world demand was not only accurate but understated and would grow like a weed perpetually under shrinking fossil fuel supply and the long interval for next gen renewable resources being deployed worldwide.

Did the western lenders use the forward price curve to value Russia’s fossil fuel reserves when they lent to them?

Globalization 2.0 = who is your counterparty?

If it was fair value as of Q2 2008, there is an immense amount of debt outstanding that relies on $150 oil and its equivalent for ore, copper, nickel and their cousins, as collateral and basis for payback.

The way you can go bankrupt having $10 billion dollars in net assets is to lever $40 billion more against it. Things accelerate when your collateral is mineral or fossil fuel reserves and they get halved in value over a 60 day period.

The attraction and security to lend into emerging markets (e.g. Russia, Brazil) was the vast and plentiful reserves of natural resources that could be mined or extracted and sold into a globe that was reported by short seller and press corps everywhere to be impossibly and everlastingly short of supply.

Compounding the squeeze for many emerging markets is a practice seen in Iceland’s dire straits. The business or individual borrows under domestically issued lending instruments from foreign institutions, denominated in foreign currency (i.e. dollar or euro). The lender stipulates it as a term of the debt agreement. The contract requires you convert your real, ruble or krona to dollars or the euro, when paid out.

As credit excess falls from its own weight, global demand is retreating substantially. Emerging market currencies devalue and borrowers struggle to pay back debt facilities denominated in foreign currencies.

As a business, you’re getting half price for sales of your commodity – from the perspective of the value you used to borrow against. You also have to pay back 110% or 120% more than the debt’s face value and interest costs. They’re contracted in foreign currency (dollar, euro) and your domestic currency is devaluing against it. This can drain a nation of cash quickly.

The emerging market set up was fragile, as their boom time economies were only a few years old. Even during the best of economic times, their currencies were still not trusted and did not merit debt contracts being denominated in them.