Opinion: I have mixed feelings about the rumoured easing of mark-to-market accounting

Given my rants against mark-to-market accounting over the year, one may think I'm happy to be finally seeing some talk from the Obama administration of easing fair value accounting for financial firms:

It might be possible to modify mark-to-market accounting rules for U.S. banks facing steep write-downs of troubled assets without abandoning the underlying accounting standard, a senior Senate Democrat said.

Sen. Christopher Dodd, the Democratic chairman of the Senate Banking Committee, told reporters on Wednesday evening after a panel hearing that at least one former bank regulator was discussing how to approach the difficult issue without "walking away from" mark-to-market standards.


Supposedly the huge rally in the markets today was due to speculation over this, so the market loves it--at least in the short-term. I personally have mixed feelings about this.

I have neither an accounting background nor do I work in the financial industry; but from what little I know of it, I have been extremely critical of mark-to-market accounting for more than an year. Perhaps this is an example of how an outsider, a lay investor, may have better insight than those who are in the thick of things. The only people who can seriously believe in it are those that believe in efficient markets at all times. I, as I have mentioned in the past, believe that markets can be irrational during panics and crises and hence do not like the use of mark-to-market accounting. It is not the cause of problems but, rather, it exacerbates the problems. In essence, fair value accounting boosts bubbles (since you can borrow more against assets that are rising--makes assets look better than they are) and crushes corrections (since collaping asset prices tightens everything--makes assets look worse than they are.)

Unfortunately, accountants worship the God of Efficient Markets and hence never saw the potential problems. To see how critical I am of the whole thing, I also said last year that, once all is said and done, mark-to-market accounting will be considered one of the greatest disasters of capitalism in the last quarter of the century. This is quite a bold statment to make but I really think it was a total disaster and destroyed hundreads of billions in shareholder wealth of financial institutions. Most accountants and regulators would consider my comment to be ridiculous but the difference between them and me is that I actually am an investor who is risking all my money.

Do note, though, that marking to market is proper for institutions that trade. For instance, I think investment banks who are engaged in trading activities should mark to market. But I don't think insurance companies, for example, should mark to market if they have no intention of liquidating the assets for many years or decades. Banks that plan to hold assets for the long run also shouldn't be forced to mark to the volatile market.

I don't think you should abandon fair value accounting right now. Not only is it going to cost companies many billions of dollars (in re-training accountants, re-doing statements, etc) but it also will confuse the market. So, I think the Obama administration is doing the right thing by considering relaxing some aspects of the system while retaining the system.

I'm not an expert on regulatory issues but what I would like to see is the relaxing of the rules pertaining to regulatory capital at banks. If banks do not think actual impairment reflects market prices, I don't think they should be forced to go and raise capital at steep prices (given how share prices have collapsed and bond markets are tight) just because capital shortfalls. (For those that still worship efficent markets, here is a SeekingAlpha article from Chad Brand showing how Bank of New York Mellon needing to write down $1.2 billion even though estimates based on interest and principal payment from the assets indicate losses of only $200 million.) I think if the Obama administration can slightly relax some of the rules for regulatory capital, it will help the financial system. Financial institutions that have very poor assets will still go bankrupt but those with decent balance sheets won't be forced to raise capital in a risk-averse world at exorbitant rates.

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