This is the second installment of “Providing Relief
from the Crisis.” Read the first, with editor-in-chief R. Emmett
Tyrrell, Jr.’s introduction,
here.
Mark-to-market accounting is contributing to uncertainty in the
markets, and it is leading to misdirected public perceptions.
Certainly mark-to-market did not cause the financial crisis.
Toxic subprime loans and excess leverage in Wall Street firms
were the principal causes. But many people, including American
Bankers Association members, believe that overly strict
application of mark-to-market made the crisis much worse by
creating a downward spiral of valuations based on prices in
dysfunctional markets. Furthermore, current mark-to-market
accounting is very pro-cyclical, exaggerating ups and downs. For
years, during the good times, ABA argued against strict
mark-to-market. During these bad times, we have pointed out the
need to adjust mark-to-market to reflect the dysfunctional
markets.
The misapplication of mark-to-market accounting in today’s
situation, when there is no functioning market, has unnecessarily
destroyed billions of dollars in capital. On a related matter,
the recent action by the Securities and Exchange Commission (SEC)
and Financial Accounting Standards Board (FASB) to address the
concept of “Other Than Temporary Impairment” (OTTI) was very
inadequate. The SEC attempted to resolve this issue, but FASB’s
interpretation (FASB Staff Position 157-3) muddled it again. As a
result, banks may be required to write down securities — even
though there may be no threat to principal or to cash flow —
because the markets are dysfunctional.
Congress and others have recognized the need to replace
mark-to-market accounting. During the development of the
Emergency Economic Stabilization Act of 2008, there was
unprecedented debate among legislators, investors, regulators,
financial institutions and others about the problems with
mark-to-market accounting. As a result, the Act required the
Securities and Exchange Commission, in consultation with the
Federal Reserve and Treasury, to conduct a study on
mark-to-market accounting standards applicable to financial
institutions.
ABA believes that if an entity’s business model is based on fair
value or if an instrument is held for trading purposes, market
value (as a proxy for sales price) may represent the most
relevant measure of how the instruments will be settled. On the
other hand, the lending and investment model of banks is based on
cash flows rather than market value, meaning that mark-to-market
is not the most relevant measurement. If mark-to-market is
overstating gains in good times and overstating losses in bad
times, are we providing good information to the public about the
performance of financial institutions? We think not.
Mark-to-market accounting needs to be addressed in the short-term
by improving both the definition of fair value and OTTI. In the
longer term, the efforts to move to fair value for all financial
instruments should be abandoned, and existing rules requiring
fair value should be examined to determine whether mark-to-market
is appropriate. Some tough lessons have been learned in this
environment regarding the lack of reliability and relevance of
mark-to-market accounting, which should not be ignored.
It is important that any new standards improve financial
reporting for users of financial statements. Our recommendations
will achieve that and will help reduce some of the unwarranted
uncertainty that exists in the markets. Accounting standards have
played a significant role in the financial meltdown, and the time
to repair them is now.
