The Quemoy and Matsu of the 2008 election has emerged; in other words, the obscure issue that no one knew anything about until recently and is now a red-hot concern stoking passions and creating political schisms. It’s “mark to market” accounting.
Yesterday, the House refuseniks were claiming that, by the stroke of a pen, the Securities and Exchange Commission’s chair, Christopher Cox, could alleviate the financial panic by getting rid of the requirement that assets be valued on a balance sheet at their current market price.
Today, they sort of did just that.
What's Behind Door Number One?
The mortgage-backed securities that enwrap an unknown quantity of mortgages that will default cannot be traded right now at any price. If a company is required to list them on the balance sheet as worth “zero,” then the overall health of a given financial institution would look terrible, verging on collapse. In many cases, that is not an accurate picture of what will happen in the real world, since not all the mortgages concealed in those packages are worth zero, and many prove out just like they say in the loan contract.
The Paulson bailot scheme was supposed to cure this problem by giving the Treasury Department the power to buy these securities off their current owners in return for hard dollars — taxpayer dollars — at fire-sale prices. The reason this wouldn’t really be a bailout is because, as I just said, behind all these Door Number Ones and Door Number Twos, there are items of value — Cadillacs mixed in with the ugly old goats.
With the Federal Accounting Standards Board’s (FASB) clarification, companies are allowed to make educated guesses as to the ultimate value of these mortgage securities; say, the value of the Cadillac, minus the damage from the ugly old goat chewing on the upholstery.
Here’s how the FASB put it, with some additional explanation from the Washington Post:
“When an active market for a security does not exist, the use of management estimates that incorporate current market participant expectations of future cash flows, and include appropriate risk premiums, is acceptable.”
The SEC is not telling holders of hard-hit mortgage-backed securities that they can willy-nilly slap any value on them they want.
What the SEC is saying is: You can take other factors into account when valuing them.
For some financial institutions, this change represents the difference between being regarded as credit-worthy and not. Which means lenders might lend them money tomorrow they would not have lent them yesterday.
Well, maybe not tomorrow. I assume the revaluing of these assets must follow a process and be signed off by independent auditors. But without a doubt, it’s an important change that will have an effect on the credit markets, the stock market and what Congress does next.
The question I would raise is: Does this change make it more or less likely that Congress will pass the bailout bill? Keep in mind, the conservatives in the House thought mark-to-market along with an expansion of deposit insurance could substitute for the Paulson plan. On the other hand, perhaps this changes the risk calculus applying to the taxpayer funds Treasury seeks to invest.
Of course, this is not without controversy. This afternoon, the Wall Street Journal reported that the Big Four accounting firms and consumer groups were just getting geared up to lobby to maintain “mark to market.”
“It’s just bad for investors,” said Beth Brooke, global vice chair at Ernst & Young LLP, in Washington, D.C. “Suspending mark-to-market accounting, in essence, suspends reality.”
The Center for Audit Quality, a Washington, D.C., nonprofit funded by accounting firms, is writing lawmakers to warn them against waiving mark-to-market accounting rules. Big Four accounting firms also plan to join in the lobbying effort, calculating that it is no longer safe to stay neutral.
Accountants won’t be going it alone because consumer groups don’t like the idea of rescinding mark-to-market accounting either.
“It’s absolute idiocy,” said Barbara Roper, director of investor protection for the Consumer Federation of America. “Allowing companies to lie to investors and lie to themselves is not the solution to the problem, it is the problem.”
Ms. Roper said lawmakers need to understand “that the alternative to mark-to-market accounting is mark-to-myth” and could give banks and other financial companies the freedom to value assets at inflated amounts.
If you accept these contentions, you would conclude that “mark-to-market” doesn’t do anything to heal the credit markets. Instead of a firm being forced to value their mortgage-backed securities at zero, they would value them at something else — but the lender might decide it’s still zero, because any other number is guesswork or wishful thinking.
