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Special Report
Facile Accounting
It’s killing Arianna, but last week’s easing of the mark-to-market rule is giving economic recovery a chance.
Liberal gossip monger Arianna Huffington ought to know by now that it is better merely to be thought a fool than to open one’s mouth and remove all doubt.
On Sunday’s This Week, Huffington provided an ahistorical account of the so-called mark-to-market or “fair value” accounting rule that forces businesses to value their assets at zero or pretty near zero when markets for those assets temporarily disappear. In a major bean-counting breakthrough that boosted bourses, the rule was eased April 2.
This is significant because since the Financial Accounting Standards Board (FASB) modified its accounting fiat known as Rule 157 (a.k.a. FAS 157) last week, banks are no longer being forced to value their assets at current market prices if they believe the market is illiquid and that most recent transactions are being carried out by distressed sellers offering fire sale prices.
Right now left-wingers like the rule because it reinforces their argument that more government intervention in the marketplace is needed. The rule hurts the capitalist villains in their anti-market narrative that holds business and the profit motive responsible for all that is bad in society. It reinforces their cartoonish claim that the actions of evil money lenders — as opposed to misguided government policy makers — were primarily responsible for the current recession.
Huffington’s know-nothing bloviations about the rule change illuminate this liberal delusion:
This week, we saw so many concessions to the banks. We saw the suspension of mark-to-market, which is absolutely tragic. Japan, by not having mark-to-market, made it much harder for them to recover…so basically now it’s become mark-to-fantasy. They can put down any number they want and they are basically perpetuating all these gimmicks that have gotten us where we are. And the government is going along with that because basically [Treasury Secretary] Tim Geithner and [Director of the White House’s National Economic Council] Larry Summers and understand that world, this is their world, and this is really the world to which they keep making concessions.
Like other liberals who reflexively cheer whatever hurts the big bad banks, Huffington doesn’t seem to understand that easing FAS 157 is not a concession to banks: it’s a concession to reality. The mark-to-market rule is the accounting gimmick, one that overstates losses and makes things seem worse during a crisis than they actually are.
The rule is fundamentally unfair to financial institutions and market participants — especially long-term investors — and directly contributed to the current economic crisis.
In October, former Federal Deposit Insurance Corp. (FDIC) chairman William Isaac blamed FAS 157 and an overzealous Securities and Exchange Commission for destroying “$500 billion of bank capital by its senseless marking to market of these assets for which there is no marking to market, and that has destroyed $5 trillion of bank lending,” he said.
Economists Brian S. Wesbury and Robert Stein wrote much the same thing in Forbes in February:
By wiping out capital, so-called ‘fair value’ accounting rules undermine the banking system, increase the odds of asset fire sales and make markets even less liquid. As this happened in 2008, investment banks failed, and the government proposed bailouts. This drove prices down even further, which hurt the economy. And now as growth suffers, bad loans multiply. It’s a vicious downward spiral.
They insist that in the 1980s and 1990s there were “at least as many, and probably more” nonperforming loans in the nation’s banking system as a percentage of the overall economy. The difference was that the mark-to-market rule was not in effect then. Its absence allowed banks the time they needed to deal with their problems.
While this was happening in the Reagan-Bush 41-Clinton years, Wesbury and Stein continued, the federal government slashed marginal tax rates and raised interest rates, which spurred economic growth. “Time and growth allowed those major banking problems to be absorbed, even though roughly 3,000 banks failed, without creating an economic catastrophe,” they wrote.
The two economists note that the late great economist Milton Friedman also warned of the dangers of pigheaded accounting rules.
Friedman wrote that mark-to-market accounting was used throughout the Great Depression and contributed to the death of many otherwise viable financial institutions. President Franklin Roosevelt wisely suspended it in 1938. America did without it for nearly 70 years until, like a vampire, it somehow came back to life in 2007 after a series of major accounting-related corporate scandals.
About the Author
Matthew Vadum is an award-winning investigative journalist at a conservative watchdog group in Washington, D.C. Vadum is also author of Subversion Inc: How Obama’s ACORN Red Shirts are Still Terrorizing and Ripping Off American Taxpayers.
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James Mulcahy| 4.7.09 @ 7:25AM
As I Said Last December on these pages:
James Mulcahy| 12.11.08 @ 7:52AM
As I said in a letter to the editor in Tuesday's edition:
"FASB and the SEC have dug their heels in to maintain MtM rules in the face of the severe damage they are doing. They justify this position by saying that it allows the market to know the "true" value of the assets held. If that is the reason for doing so, then compel institutions to put in the footnotes to their financial statements the MtM valuations and explain why they differ, if they do, from the values on the balance sheet. Investors will have as much information but the credit and capital markets won't be held hostage. "
MtM accounting does provide investors with information. 9The S&L;debacle actually started in the late 1970s with the Carter era inflation. If the S&Ls;had been required to show a market valuation of their assets at that time, public policies would (should?) have been different. ) However, it shouldn't be allowed to trump everything. MtM is useful for identifying a lone culprit in mismanagement. It exacerbates minor problems when it becomes industry-wide.
For the life of me, I can't understand the reluctance of the SEC & FASB to make the change I propose above. It would do more, and do it much quicker, to get credit flowing than all of the bailouts the pols can gin up.
Pingback| 4.7.09 @ 8:21AM
The American Spectator : Facile Accounting | Money Blog : 10 Dollars : Money Articles links to this page. Here’s an excerpt:
Bilwick| 4.7.09 @ 8:53AM
The continuing odyssey of Arianna Huffington . . . from millionaire-shtupper to State-shtupper. She's to economics what Sling Blade is to calculus.
Howard Ino| 4.7.09 @ 9:24AM
Paulson and company damn well knew what they were doing. The transfer of wealth and the billions of "lost" investment... our tax money was not by chance.
We should DEMAND an independent council to investigate the Treasury, The Fed, The Administrations, The Congress, The Banks, The SEC, et al, from Bush 1 to today and let's put the crooks in jail... for life!
Tea Party April 15!
Bram| 4.7.09 @ 9:58AM
"They can put down any number they want"
Darn it! I wish Arianna had told me that before I wasted all that money on Finance and Accounting classes. Why calculate the present-value of a revenue stream when I can just dream up a number? That's sure going to be a time-saver!
Trotter| 4.7.09 @ 10:31AM
Uh, Arianna darling, we had mark-to-market WHEN the market crashed.
A more sensical approach would be to abolish the rule, then ensure that the auditors and regulators actually know what the heck it is they're doing.
ncatty| 4.7.09 @ 10:42AM
Good job Mulcahy. People who make accurate predictions should be acknowledged. Where are we going to be in six months, 12 months and 18 months?
Rantly McTirade| 4.7.09 @ 11:16AM
It is simply pathetic when 'conservatism' means support for fraudulent financial recordkeeping. M2M is applied only to those assets that banks initially choose at the time of purchase, and the purpose of financial statements is to give an accurate snapshot of a firms' condition at a discrete moment in time and the market value of assets at that moment-no matter how 'distressed'-is what should be used for said snapshot-unless someone is concerned that an accurate snapshot would exposure incompetence, corruption or both.. This craven capitulation by FASB is simply another move at avoiding the exposure of the massive incompetence, greed and crowd-following that the 'management' of most large financial firms engaged in in recent years, and the braying of said 'managers' rented lackeys in Congress-which the FASB spinelessly caved to- confirms the ownership of the executive and legislative branches by the firms of the FIRE economy, as outlined in Simon Johnson's article in the Atlantic. Further, citing econohack Brian Wesbury automatically diminishes ones argument from the get go-even if one is arguing that the sun does indeed rise in the East.
rodan| 4.7.09 @ 12:10PM
Conservatism stands for sunlight, which is the last thing the Obama administration wants. Transparency would reveal how deep the Democrats are in this banking mess and how badly Fanny and Friends contributed.
Bob| 4.7.09 @ 12:46PM
Rantly, Vadum is mostly right on this one. M2M works when there is a market. When a market collapses, it creates paper losses even though the underlying security may be sound. FASB is not getting rid of M2M, but creating an exception where no market exists. The real answer is to provide M2M financial reporting so an investor can see both sides of the equation and then value risk.
You are right that Wesbury is a political hack, but when I challenged him on his assumptions a few months ago, he relented and said the points I made were valid. So while he skews data to the right, he is relatively honest and I give him a great deal of credit for that. Honesty and objectivity are rare on the political extremes.
Joe B| 4.7.09 @ 1:13PM
Zsa Zsa DaBore is a publicity seeking fool. She's too old and not quite glamorous enough to make it in Hollywood, but in DC, aka Hollywood for ugly people, she's a top tier celebrity.
Colin | 4.7.09 @ 6:06PM
As my wise old momma used to say: " Son, it's not proper to speak ill of the ... brain dead."
Thank you, Momma. And goodnight, Arianna.
Pingback| 4.7.09 @ 7:09PM
The American Spectator : Facile Accounting links to this page. Here’s an excerpt:
Roy| 4.7.09 @ 7:12PM
This doesn't seem to be a conservative v. liberal issue - lots of conservatives think this is a no-brainer but I have my serious doubts.
Partially I just have a strong visceral dislike for what I perceive as humbug and "toxic asset" and "illiquid market" both give off strong whiffs of raw humbug. An "illiquid market" would appear to mean "a market where people won't pay what you want them to" and a "toxic asset" would appear to mean "an asset people won't pay what you want them to for" but both are used as if they had some sort of transcendent meaning.
It has been 6 months. By now, if these assets were worth what the banks say they are, there would be buyers. In reality, as far as I can tell, the banks are asking for ludicrous prices because they think that the government will bail them out. Nobody is willing to pay those prices. Abracadabra! "Illiquid market" for "toxic assets". If the government were to say loud and clear that there will be no more bailouts, that market would become liquid right quick.
I don't have a problem with some caveats to avoid fire-sale prices becoming the standard, but let's get real here, lots of people hold these assets and there is no way anybody can get away with saying there have been nothing but "fire sales" for the past 6 months.
Suspending mark-to-market may well be the best way to get banks out of regulatory capital requirements - and getting them out of those requirements may well be the way to go here - but let's not kid ourselves. If there's a run on one of these banks and the bank has to sell its assets, the "distressed" price from the "illiquid market" for "toxic assets" is, in fact, the amount of money the bank will actually have with which to pay its depositors. The taxpayers will be on the hook for the rest, including the amount that was supposed to be avoided by capital requirements. Republicans in thrall to Big Banking will be blamed.
Bayard Waterbury| 4.7.09 @ 7:33PM
The change gives the banks the right to value their truly toxic (and becoming more toxic by the day as more foreclosures bloom) assets. It's completely irresponsible, and only encourages banks to continue to carry failing assets at inflated (MtM) values because they don't have to portray their true worth. It's the "old boy" oligarchy at it's best. Proof lies in the fact that the Treasury just extended the deadline for the PPIP opening. Why? Because the "potential" investors, even with the opportunity to leverage Federal subsidy for their investment (substantial leverage) can't get the infected banks to sell their newly marked assets at their true (nearly worthless) value. The banks don't want to sell them at anything approaching their real "non-value." Is anyone aware that the true value of the assets in the troubled banks (top 20) now amounts to a potential $4 trillion dollar loss. If Tim Geitner and Sheila Bair can't persuade these infected banks to sell this crap at its true value, they will have to pursue the takeover that is coming on the horizon, and the MtM strategies will turn out to be a real red herring. Check out Paul Krugman and Simon Johnson. They both may be counted as "liberal", but infact if you read the detail in their writings, they understand the underlying oligarchy strategy to hold out as long as possible (until a few more billions can be pocketed before reality falls on them like a ton of bricks and they are gone -- to jail, or otherwise).
Bob| 4.7.09 @ 7:59PM
Roy, I think you make some valid points. However, we know there is a market when things trade. When they don't trade, there is no market. If buyers saw value in these derivatives, they would sell.
That said, virtually none of these "toxic" assets have defaulted, i.e., mortgages are still being paid by at least 80% of the derivative base. Theoretically, that would mean they are worth only 20% less. I don't see any way they will lose more than 30% of their total value. That said, they are so difficult to value from the bottom up, that this is a guess. The real problem is that with M2M, it ties up capital the banks could use to make loans. Normally, with securitization, the banks package and sell these off and make more loans. Changing the accounting rules will not change the value of these securities -- it will just free up capital for the banks to lend.
The problem with bottom up valuation of these derivatives is that they are each small slices of tranches of securitizations. It would take a supercomputer to value these things based upon the base mortgage, default rates, locality, etc. By the time you program this into a supercomputer, it will be a decade from now.
Therefore, as long as investors know the downside, they can assess how much risk they want to take. In the meantime, without capital available for business, we won't get out of the recession. The problem that existed before M2M was transparency, i.e., we didn't know the downside. If we knew the downside and the upside, it would help us make informed decisions. Whether it was on the balance sheet, then, or in the accompanying notes, at least it would be transparent.
There is no really good decision except for transparency.
Mike| 4.7.09 @ 8:15PM
Wrong, Mark to the Market is the only realistic way of pricing and there for establishing Value of a property or commodity! Is there room for judgement, sure, and when doing this one can take into account stressed sales, etc, but this rule change basically lets the banks value their assets anyway they wish!
As an investor, I would be VERY Leary of committing money to such an enterprise, you have no way of gaging the true value of such a company!
I'm in the commodity business and we mark our postions to the market at the end of every month! Do we get some wild swings in value, etc., You betcha, but it's part of the buisness and understood!
There is always an amount of subjective input, but to say such and such property will be worth this in 5, 10, 20,.... years and then value it at this project price is unrealistic and a Sham!
Look for more problems not less!
Mike| 4.7.09 @ 8:16PM
Me again, "It's a liscense to Steal!"
Period, Da END!
Roy| 4.8.09 @ 12:32AM
Yeah Bob - I've heard that argument, and it was plausible back in September 2008, but when this much time has gone by I'm just not buying that one of those genius hedge fund managers out there hasn't run the numbers. He wouldn't have to be exactly right - just enough to be within a risk premium.
When there is a fourfold difference between what buyers think something is worth and what sellers claim to think, something is irrational. What causes irrationality? Government. Government introduces coercion into the equation and throws rationality out the window. Since September 2008, if you were a bank and you really thought your assets were only worth, say, 50% on the dollar, would you have sold them for that much? Me either. I'd be sitting on my hands, waiting for the government to bail me out. Potential buyers do not believe they will be bailed out on the downside - hence, a massive discrepancy in the value. This discrepancy would exist however complicated the underlying security.
It's funny that Geithner's plan seems to be to introduce belief in a government bailout of the downside onto the buyer's side of the equation - but, in order to avoid just getting back in the same situation, to have the buyers be less regulated hedge funds so that all these issues matter much less.
I continue to believe that the most important thing to do is make clear when the government is done dinking. If they are going to take another trillion from the taxpayers, lets all get our KY but for pete's sake let's get that uncertainty out of the system.
Roy| 4.8.09 @ 10:13AM
Again, I think your points are valid. In my opinion, there are good arguments on either side and the answer for this is not clear, that's why I think both sides need to be given to investors. That's what the notes on financials are all about. Furthermore, as the FASB board has said, M2M should be there except where there is no market.
I could also accept your position as long as the financial reporting had both sides. The issue here is not financial reporting, it is capital requirements to cover potential losses so that banks can make loans again. Perhaps the solution for capital reserves should be some sort of averaging. I'm not sure there is a good solution for this one, but both sides have good points.
Dagny Taggert| 4.8.09 @ 1:13PM
If my house is on the market for sale, and I get no bids for it on Monday, does that mean it's worth zero on my balance sheet Tuesday?
Roy| 4.8.09 @ 2:03PM
Note - directly above poster is not me - I don't think he did it on purpose but still. For pete's sake TAS - PASSWORD PROTECTION.
Dagny - if your house has been on the market for 6 months, and neither your house or any comparable house is selling for within a factor of three of what you are charging for it - it ain't worth that.
Bob| 4.8.09 @ 2:05PM
You are correct Roy, that was me. I was responding and put your name in the wrong place. My bad...
Tim| 4.8.09 @ 7:45PM
If my house is on the market for sale, and I get no bids for it on Monday, does that mean President Obama will pay my mortgage on Tuesday?
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