Another Perspective

Let’s Not Forget the Accountants

Has the easing of mark to market rules made the Treasury Department's job more impossible?

By 4.15.09

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What can you say about a 17-year-old accounting rule that died? That it was beautiful?

Accounting has always been a boring subject to many people. Nevertheless, Financial Accounting Standards Board (FASB) 107, a twenty-nine page document, is emerging as analytical ground zero in the battle to fortify bank balance sheets and stimulate the flow of credit -- and jump start the economy as a whole.

Accounting, as we know it today with double entries of debits and credits, is acknowledged to have antecedents dating to the Italian Renaissance. But one must doubt that the accountants of antiquity envisioned accounting architecture to destroy financial markets like a neutron bomb, leaving no stock exchanges and only blank general ledgers.

The mark to market principles of FASB 107 have helped bring the entire world to the edge of an abyss, in which lurk financial monsters and creatures of doom, unseen for several generations. 

As the global financial crisis has played out 24/7, and the secondary market for collateralized debt obligations (CDOs) and more specifically mortgage backed securities has seized up, there are few, if any investors to be found, since they have run for the exits. This lack of investors has resulted in colossal losses due to the need of the banks and investment banks to mark to market their asset portfolios, in accordance with FASB 107. Never mind that some securities had unimpaired cash flows and were performing as agreed -- or that there was no market to mark to.

FASB 107 contemplates an immediate and disorderly sale environment -- what is the price if you have to sell an asset NOW?  It would be like having to write your house down to a fraction of its earlier market value, so that you could sell it in a matter of minutes, electronically on eBay perhaps, or while riding on public transportation, or maybe just to the next passerby.

After the global banking system has been brought to its knees in part by the law of unintended consequences, the accounting industry has now, after the destruction of about $50 trillion of private capital in global terms (source: Asian Development Bank), decided to modify FASB 107. The intent is to be more benign to banks and to allow for valuations based on more orderly liquidation circumstances.  Given this protracted global crisis, and the many cries for reform of mark to market over more than a year, it raises the question of why it has taken so long to modify FASB 107.

While this accounting change would at first sight seem to be welcome news, by now allowing banks to value mortgage-backed securities and CDOs at prices reflecting orderly disposition and presumably intrinsic cash flows, it may make the Treasury Department's job harder in conducting private/public sector auctions. The point of the Treasury Department's most recently announced initiative to acquire at least $500 billion of distressed assets is to bring many sellers and investors together -- with minimal equity from private sources, and debt financing guaranteed by the FDIC.

Because of this modification of FASB 107, banks will now be able to carry such assets at higher valuations, and bottom fishing investors may not wish to bid so high. So the very process of market making to relieve the banking sector of toxic assets, encourage resumed credit flow, and facilitate global recovery is now potentially undermined.

For the worst financial crisis in many decades, as long as the nation is blaming Fannie Mae, Freddie Mac, the Federal Reserve, the Bush Administration, AIG, the banks and investment banks, unregulated mortgage banks and brokers, rating agencies, government regulatory authorities, Congress, populist laws that support without recourse mortgage financing, the media, the Community Reinvestment Act, rampant greed, and those folks leveraging up with bad judgment on Main Street, we need to add yet another group -- the accountants. 

The only trouble is that it may be too late in the world for accounting entries.

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About the Author
Frank Schell is a business consultant and former international banking executive. He serves on the Dean’s International Council of the Harris School of Public Policy Studies, University of Chicago where he is a lecturer.