The Corner

Re: New Accounting Rules

Vero, we’ve long held that mark-to-market rules alone were responsible for wiping billions off the value of the housing market and helped propel banks into the disaster zone by destroying their asset base. Here’s my colleague John Berlau’s reaction:

The events leading to the Dow’s climbing over 8000 today can be properly called the Mark-to-Market Relief Rally. More than any expected action of the bureaucrats and politicians at the G20, the decision expected today of the Financial Accounting Standards Board (FASB) to relax strict application of mark-to-market accounting mandates, urged by members of Congress of both parties, it what’s giving investors something to cheer for.

 

In this era that supposedly signifies the return of big government, it is heartening that on this issue, Republicans and Democrats worked together to push for this common-sense free-market reform that will do much to get our economy going and could save taxpayers billions in avoiding the need for bailouts.

 

In CEI’s recently released “Bipartisan Agenda for Economic Liberalization,” we advise Congress to “make accounting regulators accountable” and to “require regulators to suspend mark-to-market accounting mandates such as Financial Accounting Standard 157 until better guidance is developed for illiquid markets.” Thanks to members of Congress such as Paul Kanjorski, Ed Perlmutter, and Peter DeFazio on the Democratic side and Spencer Bachus, Scott Garrett, and Michelle Bachmann on the GOP side pushing FASB to reform the rules, a significant step has been taken toward this objective being achieved.

 

By itself, this change will not make the price of mortgage assets higher or lower  Rather, it will allow price discovery to occur. Mark-to-market distorted the market by forcing banks to take losses on mortgage assets even if the underlying loans were still performing, based on the last fire sale price of similar assets. Respected banking analyst Richard Bove pointed out that because of mark-to-market, Bank of New York Mellon had to value its portfolio of commercial mortgage-backed securities with a 1 percent default rate as if it had a 25 percent default rate. This resulted in a $70 billion loss of liquidity to the financial system from this bank alone.

 

With the expected change to mark-to-market today, whether banks hold or sell toxic assets should not be a concern. Either way, this rule change will help keep toxic assets from weighing down banks’ “regulatory capital” and unnecessarily tightening the lending they do. And it will save taxpayers billions by letting the market simply value the assets at prices similar to what government programs such as Treasury Secretary Tim Geithner’s Public Private Investment Partnership seek to buy them for.

 

The concerns about FASB’s independence is also misplaced. Rather, the concern should be that this quasi-private board, whose edicts are embedded in federal regulations and have a profound affect on the economy, is unaccountable to the American people. Many accountants, economists, and other experts have long criticized mark-to-market for being pro-cyclical, resulting in assets being valued too high during a boom, as when Enron utilized mark-to-market to manipulate its earnings, and causing a downward spiral during a bust. Yet FASB refused to take those concerns under consideration until Congress pushed it to.

 

Saying that only accountants can determine accounting policy in federal regulation is like saying that only members of the military can make policy regarding war. Today’s change in mark-to-market rules is a good first step toward restoring the accountability of big accounting bodies like FASB and the Public Company Accounting Oversight Board.

I should add that some are trying to spin the market rally today as reaction to the G20 statement. I suspect it’s more a case of powder kept dry.

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