Thursday, October 2, 2008

Wolves Circle Mark to Market

Momentum Gathers to Ease Mark-to-Market Accounting Rule
Critics of the proposed changes to the "mark to market" rules say gains created by easing the rules would be illusory and would delay resolving genuine doubts about the value of mortgage assets that has caused the recent crisis in confidence. As of Wednesday, the industry appeared to be gaining support for easing the rules, in part because some lawmakers believe it could cut the cost of a potential financial-industry bailout.

Banks and a diverse coalition of lawmakers scored a victory on the issue Tuesday, when the SEC and Financial Accounting Standards Board issued "clarification" to the mark-to-market accounting rules.

The SEC and FASB stopped short of bowing to pressure for a complete suspension of fair-value accounting. But that pressure could intensify when the rescue bill reaches a House vote. Financial-industry lobbyists' work on the financial-markets bill has given them another opportunity to press their case through allies in Congress, many of whom are big recipients of campaign money from the industry. More than 60 lawmakers -- all but five of whom voted against the bill Monday -- wrote to the SEC Wednesday, urging the regulator to immediately suspend the mark-to-market rule.

Accounting firms and investors groups put up a united front Wednesday in opposition to the changes. "Suspending fair value accounting during these challenging economic times would deprive investors of critical financial information when it is needed most," said the Council of Institutional Investors, Center for Audit Quality and CFA Institute in a joint statement. "It would not help solve our economic difficulties."

Republican presidential candidate John McCain, in a statement, praised the SEC clarification, saying, "There is serious concern that these accounting rules are worsening the credit crunch, making it difficult for small businesses to stay afloat and squeezing family budgets."

"We have all seen what can happen when institutions are allowed to mask huge losses in asset values," PricewaterhouseCoopers LLC Chairman Dennis Nally wrote in a letter to Congress. Suspending the rules, he said, could "plant the seeds for the next crisis."

That hasn't swayed fiscal conservatives in the House, who cite the need to suspend mark-to-market rules in explaining their opposition to the rescue bill. "One of the best reasons to fire [SEC Chairman] Chris Cox is the refusal to deal with the problem of mark to market," Rep. Darrell Issa (R., Calif.) said on MSNBC this week. "You do that, and you put trillions of dollars back into the lending pool. ... It's a tool that's available [to] the SEC, the Fed, the FDIC and the Treasury secretary, and they're not using it."

Is Debate Over Mark-to-Market Just a Waste of Time?
In an excellent post on the Curious Capitalist blog, Justin Fox makes a point that may make the whole debate moot. “Investors and regulators and reporters and corporate executives need to learn not to take any financial reporting numbers, whether marked-to-market or not, at face value. The health of a bank or any corporation can never be adequately measured by a single bottom-line number. Understanding the assumptions and uncertainties inherent in accounting numbers is crucial to understanding how to use them,” he writes.

In the current environment, everyone seems to be taking Fox’s advice. That may be one reason why these markets are frozen in the first place. Even if mark-to-market rules are suspended immediately, it won’t change the makeup of a company’s balance sheet. Investors have decided that these assets are toxic and no matter how a bank accounts for them in its books, that sentiment isn’t likely to change unless investors see some proof that the instruments are actually undervalued. So far, there’s been little to suggest otherwise.

Steve Forbes: Ease Mark-to-Market Rules
Famed business magazine publisher Steve Forbes says there's a relatively simple way to help solve the financial mess on Wall Street — ease mark-to-market accounting rules. "Short-term assets should not be given arbitrary values unless there are actual losses. The mark-to-market mania of regulators and accountants is utterly destructive. It is like fighting a fire with gasoline," Forbes wrote in the Oct. 6 issue of Forbes magazine.

Forbes recommends that investors think of the mark-to-market mess by using the following metaphor: A person buys a house for $250,000 and then takes out a $250,000 fixed-rate mortgage for 30 years. The person's income is adequate to make the monthly payments. "But under mark-to-market rules, the bank could call up and say that if your house is not sold immediately, it would fetch maybe $200,000 in such a distressed sale. The bank would then tell you that you owe $250,000 on a house worth only $200,000 and to please fork over the $50,000 immediately or else lose the house," said Forbes.

"Absurd? Obviously. But that's what, in effect, is happening today. Thus, institutions with long-term assets are having to drastically reprise them downward. And so the crisis feeds on itself."

Making the case for mark-to-market rules
There's a segment of the political and banking world that wants to toss out mark-to-market accounting rules, on the logic that they create those nasty, inconvenient writedowns. There's a growing constituency telling regulators and politicians to leave mark-to-market accounting rules just as they are, thank you very much.

There is no debate over the real financial pain that can result when the value of a illiquid, complex security has to be pegged in a market plagued by unprecedented chaos. But the alternative to pain is denial, or worse.
Trust me accounting – allowing banks and other financial players flexibility in setting the values of securities they hold - isn't likely to solve the credit crunch. It's just going to make it worse. It creates an enviorment rife with uncertainty, and open to fraud.

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