Saturday, October 4, 2008

Enron was the pit canary, but its death went unheeded
History is repeating itself as companies hide debt, blame the market for their failings and expect the taxpayer to pony up

Today's mark-to-market saga has a new twist. The SEC is facing political pressure to abolish mark-to-market accounting requirements for financial institutions, and some in Congress would like to dig mark-to-market's grave. Said in another way, now financial services firms may be allowed to deceive investors about their status, with the regulators blessing that deceit. (An aside here. Those who say mark-to-market should be abolished argue that because there is no market, firms are being forced to value these securities at artificially low levels. But there is no market precisely because firms aren't willing to sell at a price at which a reasonable investor would buy.)

Mark-to-market accounting stays, albeit 'clarified'
But we haven’t heard the end of this. The bailout law requires the SEC to conduct a study of mark-to-market accounting, assessing the effects on banks’ finances. One question Congress wants addressed is "the impact of such accounting on bank failures in 2008" -- in other words, are the bookkeeping rules hastening the demise of banks without good reason?

SEC gets power to suspend the mark-to-market accounting rule
The bill gives more heft to guidance the SEC issued on mark-to-market accounting on Sept. 30, says Michael Bopp, partner at law firm Gibson, Dunn & Crutcher. The SEC said companies are not required to mark assets to values that result from thinly trading markets.
But the real effect of the bill won't be known for some time, Bopp says. The SEC is required to study mark-to-market accounting and its role in recent bank failures and deliver results in 90 days.


Other Pathways Out of the Financial Crisis
A year ago, I heard warnings about the mark-to-market rules from Joe Robert, who runs a global real estate investment firm called J.E. Robert Cos. He argued that these rules were forcing financiers to sell into a declining market and assign rock-bottom valuations to assets that, if held to maturity, might be far more valuable.

Robert offers a simple example of what the mark-to-market regime has done: Imagine a street where the houses are all worth $1 million and each has a $500,000 mortgage. But a clause specifies that if a house's value declines to less than double the loan, the mortgage will go into default. Now, suppose one homeowner is forced to sell and has to accept a lowball offer of $600,000. Using mark-to-market rules, the lender would have to judge all the other homeowners technically in default, forcing them to raise additional cash or perhaps sell their homes. That's what has been happening in the financial world.

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