Thursday, October 2, 2008 0 comments ++[ CLICK TO COMMENT ]++

Mark-to-Market Accounting Turning a "Large Problem Into a Humongous One"

Briain Wesbury argues that mark-to-market accounting is making the situation worse (thanks to for the original citation):

Mark-to-market accounting rules have turned a large problem into a humongous one. A vast majority of mortgages, corporate bonds, and structured debts are still performing. But because the market is frozen, the prices of these assets have fallen below their true value. Firms that are otherwise solvent must price assets to fire-sale values. Not only does this make them ripe for forced liquidation, but it chases away capital and leads to a further decline in asset values.

For example, the prices of assets on the books of Washington Mutual, when it was bought by J.P. Morgan at a fire-sale price, were cited as a reason to mark-down the assets on the books of Wachovia. This, some say, forced the FDIC to arrange its sale to Citibank.

The same is true of what happened to Fannie Mae and Freddie Mac, which had positive cash flow when they were nationalized by the Treasury. Here's something you won't believe: Fannie Mae and Freddie Mac have not drawn a dime from the Treasury's $200 billion facility that was created to bail them out. It was the use of mark-to-market accounting that allowed Treasury to declare them bankrupt. On a cash flow basis, they were solvent.

The Fannie and Freddie takeover was very dubious. If it were me, I would have let them earn their way back. However, there were quasi-governmental entities and hence were always under threat from government actions. In any case, there are many fans of fair value accounting, including Warren Buffett, but I maintain my view that this is going to go down as possibly some of the worst changes in accounting history. The sad thing is that even the fair-value fans aren't sure if the marked value is anywhere near the true value of the asset. They somehow seem to have blind faith in the marks while being unable to have any confidence that the marks actually represent anything close to the truth.


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