Holman Jenkins explains:
Mark-to-market accounting is fine for disclosure purposes, because investors are not required to take actions based on it. It’s not so fine for regulatory purposes. It doesn’t just inform but can dictate actions that make no sense in the circumstances. Banks can be forced to raise capital when capital is unavailable or unduly expensive; regulators can be forced to treat banks as insolvent though their assets continue to perform.
What happens next is exactly what we’ve seen: Their share prices collapse; government feels obliged to inject taxpayer capital into banks simply to achieve an accounting effect, so banks can meet capital adequacy rules set by, um, government.
But wait! I thought that the problem was all of the (non-existent) “deregulation” and “tax cuts” of the Bush years!
It would help if we could get rid of, or at least reform Sarbanes-Oxley, too, but little hope of that with this gang in charge.
[Update mid afternoon]
Stop favoring the short sellers.
[Update a while later]
Michael Barone: “Ad hoc Fed, Treasury Actions Caused Crisis, Not Deregulation And Tax Cuts.”
Well, duhhh. But reality didn’t fit the Messiah’s message.
The banks loved mark to market as long as asset prices were increasing. It drove profits higher and impacted decisions about where next to allocate capital. They are outrageous hypocrites to complain about it now.
I might add that Warren Buffet has quite a bit of skin in the matter. He owns more than a few of the distressed assets which , if sold in the market today, wouldn’t fetch much. He desperately wants not to have to report that market value to his shareholders.
So, what’s your point? That we should continue to wreck the economy because some bankers and Warren Buffet are hypocrites?
The bankers may be hypocrites, but that doesn’t make the suggestion a bad one. It’s a good idea on the merits that the debt/asset ratios should be shareholders but should not force a bank to dilute its equity when it’s in no one’s interest to do so.
Another way the Government caused this is by having different tax rates for income and capital gains. Investors prefer share price increases to dividends of the same dollar value because of the preferable tax treatment given capital gains, but once the lending sector is saturated the only way a bank can grow its share price is by taking on more risk and moving into new markets. This creates systemic risk to the whole economy when bad bets made by speculative investment companies threaten the lending institutions under the same corporate umbrella. What should be the safest business in the world becomes incredibly risky, requiring bailouts.
Ok, this is the kind of nuanced approach that I can support. Continue to use mark-to-market accounting for reporting the state of health of the corporation and tooth fairy accounting for government-mandated actions.
Karl,
if Mark-to-Market seriously undervalues -or- overvalues the long term worth of an asset isn’t it the real tooth fairy accounting? What is the instant market value of a bank’s Miami office tower the day before a class 5 hurricane makes landfall? What about A similar building located on prime California real estate in early 2006 at the height of the boom?
Mark-to-Market is useful for knowing the value of an asset if you need to liquidate everything NOW, but it is terrible for determining the real value of a going concern. Let’s use mark-to-market for risk disclosure, but treat the business as a going concern and let them take into account the long term value of their assets until they are facing actual bankruptcy, not some fanciful “what-if” scenario.
Sorry Rand. My point is that I like mark to market accounting, in good times and bad. In bad times it is especially important because mark to market filters the good decision makers form the bad ones; the solvent institutions from the insolvent.
Since the great depression there have been two ways to deal with insolvent banks. One, reorganize them by eliminating current shareholders’s equity, mark the asset’s(loans) value to market and redistribute that value to bondholders as equity, after calling their bonds. Or, two, if there is not enough value in the loans to guarantee the deposits, then you liquidate the bank in its entirety and distribute the loans and deposits to other more solvent institutions and the government picks up the difference between the loan value and the FDIC guaranteed deposit amount. That’s the way it has worked for seventy years at minimal cost to the taxpayer.
The reason the big money center banks are railing against mark to market is because most to them will proceed directly to the second step outlined above. They say the depressed value of the loans is an extraordinary event. Not so, The heightened values of real estate on the two coasts is the extraordinary and unsustainable event. What’s dragging the loan’s value down is the inevitable fall of real estate values from those highs.
For a fact, there are thousands of small and medium sized banks in the USA that don’t have these balance sheet problems. They did not make the same decisions that Citi, BofA, Chase, Wachovia, et al made. They are more than able to acquire assume the deposits and acquire the depressed assets of the aforementioned. I say let them. It will be far cheaper.
Jardinero1, mark-to-market accounting rules amplify financial market problems. Mark-to-market accounting existed in the Great Depression and according to Milton Friedman they alone were responsible for the failure of many banks.
FDR suspended m2m in 1938 and and they stayed suspended until 2007 (during which time there were no panics or depressions). But when FASB 157 went into effect in 2007, reintroducing mark-to-market accounting, look what happened.
> mark to market filters the good decision makers form the bad ones; the solvent institutions from the insolvent.
Except that it doesn’t.
Suppose that I own a rental property that is throwing off enough cash to meet my obligations.
Am I insolvent on a day when I can’t find a buyer? How about the day when no one bids on comparable properties?
I firmly believe that the destructive effects of FASB’s change to a mark-to-market accounting standard in November 2007 cannot be overstated. It never made any sense, and the proof of this is that neither Paulsen nor Geithner have been able to do what they set out to do, which was to buy up the so-called “toxic assets.” The problem? They can’t determine a fair price for assets which have been devalued on paper to effectively nothing because of the new mandated accounting standards.
Yet Geithner said recently that these assets have “inherent value” that is not reflected by their current market price, which is an implicit repudiation of the mark-to-market standard. It’s also the reality he has to face. Hence the problem, a kind of Catch-22 of his own making. (He and others, to be fair.)
To buy up the toxic assets at higher than mark-to-market value would admit what everyone knows but won’t speak: that these assets are worth a lot more than the mark-to-market value and always were. If the government hadn’t forced the financial companies to grossly understate the value of their assets in the first place, this banking crisis might never have occurred or at least not nearly at this degree of severity.
Furthermore, if Geithner believes the assets are worth more than the mark-to-market value, then why not simply change the FASB rules back to what they were pre Nov2007 and let the financial companies mark them up on their own balance sheets instead of selling them back to the government? Same reason. Because if the government were to now admit that these assets are, in fact, worth quite a bit more — and that they always were — the smoking gun would be revealed. And so would the fingerprints of all those who helped pull the trigger.
I answered more fully in Rand’s follow up article. But to summarize, I think you are very wrong here. My take is that nobody has a better idea of what these assets are worth than the market. And if it’s pricing those assets lower than the owners of the assets would like, then too bad.