Herewith the first installment of an economic symposium that
Brian S. Wesbury, our economics editor, has put together in the
hope that the present financial crisis can be relieved without
much more pain for the taxpayer. We believe that a major cause of
the ongoing credit freeze is mark-to-market accounting rules that
the Securities and Exchange Commission could simply suspend. Over
the next three days we shall publish seven pieces — two a day —
in this symposium titled “Providing Relief from the Crisis”
wherein some of the country’s top economic thinkers argue that
the government especially through its enforcement of
mark-to-market accounting rules, has deepened and broadened the
crisis. In fact we believe that the current crisis has burned out
of control because of the government’s obduracy in refusing to
admit that its polices have made things worse.
In their seminal work, A Monetary History of the United
States, Milton Friedman and Anna Schwartz reported that
mark-to-market accounting rules caused banks to fail in the Great
Depression, not from bad loans, but from writing down bond values
at the behest of regulators. And as William Isaac, former head of
the FDIC, tells us in his submission, FDR eventually called
together a panel in 1938 that suspended those rules. By then the
Depression had lasted eight years. We hope our current government
leadership understands this history. — R.
Emmett Tyrrell, Jr.
THE PRESIDENT-ELECT should immediately call upon the Securities
and Exchange Commission to suspend mark-to-market accounting
(specifically SFAS 157, adopted in 2006). It’s indisputable that
this accounting rule has senselessly destroyed hundreds of
billions of dollars of bank capital, is a major cause of the
world-wide financial crisis, and is crippling the economy.
The SEC began pushing for market value accounting in the early
1990s. The move was opposed strongly by Treasury Secretary
Nicholas Brady, Federal Reserve Chairman Alan Greenspan, and
Federal Deposit Insurance Corporation Chairman William Taylor.
Greenspan and Taylor pointed out that market value accounting on
bank investment portfolios had been required by regulators until
1938. That year President Roosevelt asked the Secretary of the
Treasury to convene the bank regulators to discuss how to get
banks lending again to help the nation recover from the Great
Depression. They concluded that market value accounting was
impeding bank lending and abolished it in favor of
historical-cost accounting.
Brady was prescient in his 1992 letter opposing market value
accounting. He noted that market value accounting would introduce
a great deal of volatility in bank earnings and make their
financial statements more difficult to understand. Most
importantly, he cautioned that temporary changes in market
pricing could cause large hits to bank earnings and capital,
which would diminish bank lending capacity and create severe
credit crunches.
I considered market value accounting when I was Chairman of the
Federal Deposit Insurance Corporation during the banking crisis
of the 1980s. I thought it might force banks to keep the
maturities of their assets and liabilities in better balance. The
FDIC ultimately rejected the notion for three principal reasons.
First, market value accounting could be implemented on only a
portion of the asset side of bank balance sheets (i.e.,
marketable securities) — it was daunting to even contemplate the
liability side. A system that captures one change in value
without picking up other changes can be very misleading. For
example, an increase in interest rates would drive down the value
of fixed-rate mortgages and bonds held by banks but might well
increase the value of their floating rate loans. That same
increase in rates would make most deposit accounts more
profitable. The net affect on a bank’s business could be
positive; yet, marking the government mortgages and bonds to
market would destroy earnings and capital.
Second, we believed that market value accounting would impede
banks in performing their fundamental function — taking
short-term money from depositors and converting it into longer
terms loans for businesses and consumers.
Third, we felt that market value accounting would be pro-cyclical
and would make it very difficult for regulators to manage future
banking crises. If we had followed market value accounting during
the 1980s, we would have forced the nationalization of our
largest banks, which were loaded up with third world debt for
which the markets were not functioning. I believe the country
would have gone from a serious recession into a depression.
Devotees of market value accounting cringe at the thought of
suspending the rules. They argue it would result in a loss of
transparency and an overstatement of values. To the contrary,
market value accounting has produced terribly misleading
disclosures by valuing specific assets well below their true
economic value without considering offsetting changes in value of
other assets and liabilities. It is transparently bad accounting.
Historical-cost accounting — the cornerstone of Generally
Accepted Accounting Principles — is vastly superior. Under
historical-cost accounting, marketable assets are carried on the
books at their amortized cost, and the balance sheet contains
footnoted tables showing the current market value of those
portfolios. This gives investors all of the information they need
to evaluate the adequacy of a bank’s capital and its earnings
power.
Historical-cost accounting does not run market depreciation
through the income statement and does not deplete bank capital
(unless the decline in value is considered permanent). This
system provides a more accurate financial picture of a bank and
does not destroy bank lending capacity.
The crisis in the financial system demonstrates that major
principles of accounting are much too important to be left solely
to accountants — or, worse yet, to an international board of
accountants, as the SEC is currently considering. We urgently
need to change our system of setting accounting standards to make
it more accountable. Accounting principles affecting our
financial system should require approval from both the Federal
Reserve and the FDIC — the two agencies charged with maintaining
stability and picking up the pieces when a crisis hits.
It makes no sense to allow the SEC and the Financial Accounting
Standards Board to continue destroying capital in our banks at
the same time Treasury is using taxpayer money to recapitalize
the banks. Our new president should call upon the SEC to get on
the same page as the rest of the government and end the
destruction of bank capital under SFAS 157.
