Wednesday, October 1, 2008

Accounting Mayhem at the Wall Street Journal

After a couple of weeks of singing from the investment banks’ songbook on mark to market/fair value accounting, the Wall Street Journal now does a gigantic triple backward flip flop and says accounting is meaningless:

Mark to Mayhem?
Because of all this, the regulatory state finds itself in a somewhat absurd position -- its own rules could render many financial institutions insolvent in a manner inconvenient to the state.
We choose the adjective advisedly. These institutions are guaranteed by the federal government, implicitly or explicitly, so questions of solvency are largely academic--except as to the value of their equity. In fact, much of the ferocious argument over mark-to-market really is a political battle between CEOs and short sellers for control of the stock price. Washington wishes they'd just shut up before savers and lenders join the argument -- because, in present circumstances, we'd call that a "bank run."

Then there's a third group on the sidelines who attribute religious or ethical superiority to mark-to-market. Their sentiments are simply misplaced. Mark-to-market and its alternatives all have their uses -- a rose by any other name. A savvy analyst looks at them all with the same gimlet eye.

But usefulness is not what we're talking about here -- we're talking about a regulatory trap for equity, created as an unintended consequence of a well-meaning accounting rule. Short sellers see this trap and try to exploit it. Uninsured lenders and depositors see it and worry about not getting paid back. That fear is why banks have all but stopped lending to each other -- and why Henry Paulson launched his plan, and why the SEC made its move yesterday.

Accounting straddles the real and unreal, so it's hard to guess how much difference getting rid of mark-to-market might really make. The only way to find out is to try.

A mere accounting rule change won't reduce foreclosures or raise home prices -- then again, if spared drastic writedowns, banks might be more willing to lend, raising home prices and reducing foreclosures.

A mere accounting rule can't alter the underlying economics of a lending business -- then again, no longer worried about insolvency-by-accountant, investors might discover new confidence to inject capital and improve the underlying economics of a lending business.

No accounting rule is worth $700 billion. Then again, the essence of the Paulson plan was to raise the value of bank assets to help banks escape the regulatory equity trap. Does that mean we can change an accounting rule and save Congress from having to appropriate $700 billion?

Other views—
In the mainstream media
The accounting rule you should care about
A New Rule Change That Could Hurt Taxpayers
Why get a bailout when you can massage the books?
Clarification of accounting rule sparks debate
In blogs
Moving The Foul Pole: The Mark-To-Market Scandal
Changing the rules on bank accounting, the fix is in
Fair Value Follies
Fair Value Follies 2
FASB and SEC Make Nice-Nice
SEC: Why Don't You Just Tell Us What You Want The Value To Be?

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