Accounting change won’t save banking

By J Saft
March 13, 2009

James Saft Great Debate —James Saft is a Reuters columnist. The opinions expressed are his own. –

By all means reform accounting, but for pity’s sake take your time and keep your expectations low.

Suspending mark-to-market accounting immediately as a means of levitating banks out of peril simply won’t work. While transparency may or may not be the foundation of banking, trust undoubtedly is.

“Adjusting” or suspending fair value accounting, even if you swear up and down that this time it’s even more fair will erode rather than build trust and repel rather than attract capital.

The House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, led by Congressman Paul Kanjorski of Pennsylvania today is holding a hearing on mark-to-market and already the industry knives are out.

A group of 31 industry groups and financial institutions, including the American Bankers Association, Mortgage Bankers Association and U.S. Chamber of Commerce, have petitioned the committee to take “immediate action” to stop the “spiral of accounting-driven financial losses,” according to the Los Angeles Times.

They argue that current rules, which force banks to carry some securities on their books at levels that reflect current market prices, mean they have to recognize losses that “do not have a basis in economic reality”.

That’s as may be, but so far market prices have arguably been a better directional indicator of the future performance of collateral than some hopeful internally generated marks. Is mark-to-market perfect? No. Might reform, in the fullness of time, adjust some of its pro-cyclical effects? Yes. Will doing that in the midst of a crisis have the desired effect? No.

This whole effort fundamentally misunderstands the situation facing banking.

The problem facing the banking industry is not just solvency on some accounting or regulatory basis, it is solvency on, for want of a better phrase, a solvency basis. Thus banks are unwilling to do business with one another and investors unwilling to lend banks money or invest in them. They do not reliably know who is bust and who is not.

Some may possibly be tarred unfairly by mark-to-market, but allowing everyone to step back from market discipline will make investors less willing to commit capital to banks and banks less willing to do business with one another.

Regulators and accountants may turn a blind eye, but given the current set of economic circumstances people with money on the line won’t find internally generated prices for assets more inspiring of confidence than market derived ones. Quite the opposite.

– At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund –


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James is quite correct. When it all comes down to it, the banks owe way more money than they can cover. The only real “crisis” here is, now that the banquet is over no one wants to get stuck with the check.

Never mind that banks were always the first to say that government should stay out of the markets. Now that they’re broke they want the government (tax payers) to lend them some cash. When you and l can’t pay our debts, we have to file bankruptcy and have only the most basic of protections under the law. So if we make bad choices we have to eat it.

But the banks don’t want to eat it. They don’t want fold as they should. This is going to hurt one way or the other. But better to get it over with now and let the weak banks die. If that be all of them then so be it. This is only a system of exchange after all. And we can always come up with a better system. Or God forbid, maybe have some common sense when making choices next time.

the banks need to learn from their mistakes they have done in the past. i say they should have never been given any money at all. if you run a large buisiness or cant manage your money the government will bail you out, but if you are just struggling to pay your bills, you just out of luck. seems like no one in washington has a clue!

Posted by keith | Report as abusive

10 out of ten Mr. Saft. And the german demand of regulation is another (I better not type the word here).
To what benefit shall that be. It will take months if not years to put together an internationaly accepted codex. This crisis will hit Germany the hardest and world-champion-exporter must for once cooperate with and help the U.S. or Germany will sink amongst the waves.

Posted by Hans | Report as abusive

In response to Gregory about James Saft being off the wall and M 2 M should be abandoned, I can only say that I have real estate that is worth much more now than I can sell it for. I and many others take it off the market until prices stabilize. When people cannot get a loan and when foreclosures are swamping the market, prices are driven down below what they are actually worth. And people say, why should I buy now because the properties may go down more. But M 2 M is worse. M 2 M requires that business write down assets to a worthless value because no one is willing to buy them. And people aren’t willing to buy them because such assets are buried in large quantities of derivatives and the assets are obscure. If I were a bank, I would not sell assets on which I was collecting income for less than the income I was receiving if I were reasonably sure to collect. In like manner, if I have a rental and people are paying the rent and most of my mortgage payment and the current market price of my house is less than what I can sell it for, I would be better off to wait to sell until normal times return. Times of distress are not a normal market. Similarly stock prices are not realistic now. If one can hold on, things will improve. A forced seller will lose a lot of money. In the past, I have tried to sell a house during a bad market at a reasonable price and it would not sell. But when the good times returned, I sold the house for a decent profit. Please respond Greg, and I will debate with you.

Posted by Jim | Report as abusive

With respect, my perspective is that the market price is the market price. If one feels that the current market price will increase in the future and that one is right to hold out for that future price that may or may not prove a sound judgement, but it is what is referred to as speculation–a judgement.

The current price is the current price.

The problem with abandoning mark-to-market is that it allows for infinite possibilities of error and delusion, the notion that ‘I’m right, the market is wrong’. It was the poor judgement of these institutions that these markets could not possibly become illiquid or decline substantially let alone catastrophically in value, and we are now to trust in their judgement, their speculation, that they project future values more accurately than others in the market as reflected in the dearth of offers at the prices they, in their infinite wisdom and judgement, consider ‘reasonable’?

Posted by atomikweasel | Report as abusive

I haven’t really heard an explanation about the derivatives component of this mess. It’s a deep issue when people start questioning book values and when declines in value should be expensed rather than remaining capitalized. I doubt the accounting profession would consider the reverse – realizing income on increases to market value. The volatility of the markets would make this type of accounting a real headache. I can see however how somebody might try to capitalize a derivatives contract to market value. For me, insurance costs should be expensed over the life of the policy in terms of the contract buyer. The writer on the other hand if she is naked, she should buy some shorts.

Posted by Don | Report as abusive

I know this is a bit broad with respect to the immediate topic, but I have a question. Does anyone, essentially irrespective of their political orientation, have *any* confidence in Summers and Geithner at this point?

Talk about a random walk!

Posted by atomikweasel | Report as abusive

As a CPA I can only say that any change to this most basic precept of Accounting Law, Fair Market Value, is total blasphemy that will blur and twist financial reality to absurd distortion and make the government advocates of delusionary economics; the disease it is supposedly trying to cure.

Posted by RALPH JARMON | Report as abusive

The mark-to-market rules came as a result of abuses in the past by hidden Losses or Reserves. Understanding the issue and blaming the current mayhem on mark-to-market rules is rather weak attempt on a solution.
The increase in market values over the past 5 years came to drastic halt and fall should reasonably be weighed by unreasonable expectation in further wealth creation. The huge corrections, both in advance and emerging countries must be reinforced by political strength to re-build and repair the damages. Naturally, those that had voilated laws to perpetuate their own greed and wealth in suspicious manner must be bought to justice whereever juristidictions.

Whatever happened to the old accounting basis of prudence?

If all banks wrote their balance sheets down to “lower of cost or net realisable value” then what James wrote – “They do not reliably know who is bust and who is not.” would disappear.

Posted by Colin | Report as abusive

Plenty of reasonable arguments against relaxing the current standards have been presented here. The banks argue that they are being hurt by the applicable standards and that the value of the assets is higher than what the books say. That may be correct but that’s not point. The point is that markets don’t think so, the perception is what counts not the reality. Well they’ve accepted the rules and played them like the rest of us. Now they don’t like it any more? That’s bizzare soup opera. They are the main culprit in the current scenario and they have contributed to the distortions now prevalent and these are to be forgotten?. Common this is not a legal proceeding, the jury can’t be told to forget the last remark. Furthermore they’ve allways had number of instruments at their disposal allowing them to manage the unforseen (hedging, insurance etc). They’ve bee paid handsomely to do just that (extracting the meat from the bones) yet failed at managing the resources by the then applicable rules and they have now the nerve to ask everybody to look the other way? If politicians take away that principle based approach than what chance does the society’s other principles stand (legal, moral, accountability, freedom..) – all in the name of a paper profit ?

Posted by Franz Kafka | Report as abusive

In good times, they loved M2M because it inflated assets and share prices shot up. And the government also collected more taxes.

Now, M2M is making them too bad and they want to change the rules mid game?

They say the markets are irrational and do not truly price their assets. Why didn’t they say the same thing when the markets were at all-time high?

Posted by ron_paulite | Report as abusive

In good times, they loved M2M because it inflated assets and share prices shot up. And the government also collected more taxes.

Now, M2M is making them look bad and they want to change the rules mid game?

They say the markets are irrational and do not truly price their assets. Why didn’t they say the same thing when the markets were at all-time high?

Posted by ron_paulite | Report as abusive

One of the key concepts of mtm missing from this discussion is the assumption of a normal “orderly” market. Mtm works going up because supply and demand are by definition, functioning. Mtm is equally applicable in a normal orderly down market where yes, all the banks their their beatings.
But when the market collapses, what are you marking to? Liquidation prices? That is a self-fulfilling death spiral. Reg change/relief from accounting practices not intended to function in the absence of a market is necessary for the survival of the financial sector in America and elsewhere. All the stakeholders involved are feeling the pain – all for bonus clawbacks here.
This is not an argument for avoiding the consequences of stupid risk taking. Stupid risks were taken, reputations and fortunes are crumbling. But we don’t want the whole ship (which all of us are in like it or not) to go down as well. Why should someone looking to buy a house or a car now be forbidden because the banks won’t lend? Why should non-bank businesses small and large be refused normal credit lines for making payroll and basic investments in inventory and operations?
When a patient has a bad heart, we don’t cut off their head, we get their heart pumping again and put them on a restricted diet. Mtm reform must be a component of the restart plan – but only as it pertains to extraordinary market conditions for certain types of assets.

Posted by Duncan | Report as abusive