FASB and the Mortgage Secondary

FAS 141(R) did away with the "purchase method" and established the "acquisition method" of accounting for business combinations. It apparently did so out of a belief that measurements of assets and liabilities that are based on the most current information available are usually, if not always, preferable to valuations based on less-current information. The JPMorgan case glaringly points to a significant flaw in that belief: inconsistent application of fair value could be more harmful than consistent application of a less desirable attribute. As to the case at hand:

• WaMu, as is quite common, accounted for its loans based on a held-to-maturity model. That is, except for recognizing declines in creditworthiness, the loan carrying amount is based on the original contractual terms; interest is accrued by multiplying the net carrying amount by the yield to maturity as of the date the loan was originated/acquired.
  
• Even though the market value of these loans had declined significantly as they turned toxic, WaMu apparently was not required to record losses to bring the loans down to their fair values.
  
• JPMorgan, when acquiring WaMu, was required by FAS 141(R) to mark the loans to market. Subsequent accounting by JPMorgan will continue the WaMu the held-to-maturity model.
  

  It would be a pretty safe bet that JPMorgan was very 'conservative' in their estimates of fair value for the loans; that's because the lower the fair value, the higher the yield to maturity, and the higher the amount of reported future earnings. Of course, there are some limits to JPMorgan's estimate of fair value: auditor pushback, SEC review, increased risk of goodwill impairment charges, and capital adequacy regulations. But, at least in this case, it is possible to become rich without being greedy.