—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 –
Suspending mark-to-market accounting will alleviate the banking crisis and help to restore confidence. The banks will still have to take their losses, but they can write them down over time instead of being forced into insolvency right now.
This will also buy everyone some time to deal with all of the problems in the financial system. The credit default swap problem needs to be addressed. There are just too many of them, and the underlying assets have been insured multiple times over by speculators. The speculators should be wiped out.
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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.
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?
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?
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 ?
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.