mark-to-market accounting rules

The mark-to-market relief rally

by John Berlau on April 2, 2009

in Bailout Watch, Deregulate to Stimulate, Odds & Ends

The events leading to the Dow’s climbing over 8000 today can be properly called the Mark-to-Market Relief Rally. More than any expected action of the bureaucrats and politicians at the G20, the decision today of the Financial Accounting Standards Board (FASB) to relax strict application of mark-to-market accounting mandates, urged on by members of Congress of both parties, it what’s giving investors something to cheer for.

In this era that supposedly signifies the return of big government, it is heartening that on this issue, Republicans and Democrats worked together to push for this common-sense free-market reform that will do much to get our economy going and could save taxpayers billions in avoiding the need for bailouts.

In CEI’s recently released “Bipartisan Agenda for Economic Liberalization,” we advise Congress to “make accounting regulators accountable” and to “require regulators to suspend mark-to-market accounting mandates such as Financial Accounting Standard 157 until better guidance is developed for illiquid markets.” Thanks to members of Congress such as Paul Kanjorski, Ed Perlmutter, and Peter DeFazio on the Democratic side and Spencer Bachus, Scott Garrett, and Michelle Bachmann (here’s her statement on today’s action) on the GOP side pushing FASB to reform the rules, a significant step has been taken toward this objective being achieved.

By itself, this change will not make the price of mortgage assets higher or lower. Rather, it will allow price discovery to occur. Mark-to-market distorted the market by forcing banks to take losses on mortgage assets even if the underlying loans were still performing, based on the last fire sale price of similar assets. Respected banking analyst Richard Bove pointed out that because of mark-to-market, Bank of New York Mellon had to value its portfolio of commercial mortgage-backed securities with a 1 percent default rate as if it had a 25 percent default rate. This resulted in a $70 billion loss of liquidity to the financial system from this bank alone. (Bove’s analysis doesn’t seem to be available online, but is described in this brilliant article on the investor site MotleyFool.com by Liz Peek.)

With the expected change to mark-to-market today, whether banks hold or sell toxic assets should not be a concern. Either way, this rule change will help keep toxic assets from weighing down banks’ “regulatory capital” and unnecessarily tightening the lending they do. And it will save taxpayers billions by letting the market simply value the assets at prices similar to what government programs such as Treasury Secretary Tim Geithner’s Public Private Investment Partnership seek to buy them for.

The concerns about FASB’s independence is also misplaced. Rather, the concern should be that this quasi-private board, whose edicts are embedded in federal regulations and have a profound affect on the economy, is unaccountable to the American people. Many accountants, economists, and other experts have long criticized mark-to-market for being pro-cyclical, resulting in assets being valued too high during a boom, as when Enron utilized mark-to-market to manipulate its earnings, and causing a downward spiral during a bust. Yet FASB refused to take those concerns under consideration until Congress pushed it to.

Saying that only accountants can determine accounting policy in federal regulation is like saying that only members of the military can make policy regarding war. Today’s change in mark-to-market rules is a good first step toward restoring the accountability of big accounting bodies like FASB and the Public Company Accounting Oversight Board.

If there is anything regrettable about today’s action, it is that Hank Paulson and Tim Geithner didn’t push through this reform sooner and save the economy all this consternation and taxpayers all those billions. CEI has been advocating mark-to-market reform almost from the time that the current FASB rule (Financial Accounting Standard 157) was implemented in late 2007, and here is a link to an op-ed I wrote for the Wall Street Journal in September 2008 on how the mark-to-market mandate was a significant factor in spreading the credit contagion.

Markets Rally on Hopes of Regulatory Relief

by Hans Bader on April 2, 2009

in Bailout Watch, Deregulate to Stimulate, Economy, Energy, Environment, Global Warming, Precaution & Risk, Regulation, Stimulus to Nowhere

The stock market has gone up by 280 points so far today, fueled by FASB’s vote to relax rigid mark-to-market accounting rules, which require financial institutions to value assets at their current fire-sale prices, and magnify boom-bust economic cycles.

The market may also be getting a boost from the Senate’s earlier vote undercutting the Obama Administration’s proposed $2 trillion cap-and-trade carbon tax, which would impose burdens on the economy akin to Herbert Hoover‘s disastrous 1932 Revenue Act at the beginning of the Great Depression.

The market’s rise contrasts with its fall in the weeks after passage of Obama’s $800 billion stimulus package, which Obama falsely claimed was needed to avert “disaster” and “irreversible decline.” Obama made that claim even though the Congressional Budget Office, controlled by his own Congressional allies, admitted that the stimulus package would shrink the economy over “the long run.”

Many commentators have called for relaxation or repeal of mark-to-market accounting rules to stem the financial crisis, including former FDIC Chairman William Isaac, Congressmen Ed Perlmutter (D-CO) and Paul Kanjorski (D-PA), the Wall Street Journal, John Berlau, Jeff Miller, Holman Jenkins, Newt Gingrich, and the Republican Study Committee.

While pushing through $8 trillion in bailouts, and trillions more in debt from massive budget increases, the Obama administration has until recently ignored inexpensive possible ways of mitigating the financial crisis like reform of “mark-to-market” accounting rules.

The Obama administration’s footdragging on accounting-regulation reform is inconsistent with the rationale for its trillion-dollar toxic-asset buy-up program, which defies mark-to-market concepts in a much more extreme way than a mere relaxation of mark-to-market accounting rules. The Treasury Secretary claims taxpayers won’t lose a full trillion under Obama’s toxic-asset program, because the assets aren’t as worthless as their current market prices suggest. But if that’s true, why did he continue to insist on federal accounting rules that force banks to value their assets at the current depressed market prices? Either the accounting rules were right — in which case taxpayers will end up losing a trillion dollars — or they were wrong, amplifying financial panics — in which case the rules should be repealed, so that banks, not taxpayers, will be able to take the risk of holding the assets. (If these accounting rules, known as “mark-to-market” accounting, had been in place in the late 1980s, “every major commercial bank would have collapsed,” wiping out the economy).

It’s not even clear that all these bailouts are needed. As William Seidman, the banking official who helped clean up the S&L Crisis as head of the RTC, notes, the government’s $170 billion AIG bailout was absurdly expensive and wasteful. “We paid off huge debts that AIG had in the swaps market, which we probably did not have to do. We bought a number of assets from AIG at high prices, which we probably did not have to do.”

That includes a huge unneeded windfall for the investment bank formerly headed by Treasury Secretary Paulson, Goldman Sachs, a major donor to liberal politicians, which received billions of dollars from taxpayers that it did not even need, through the AIG bailout.

Obama’s record-breaking tax and spending increases violate his campaign promises to enact a “net spending cut” and not to raise taxes “in any form” on anyone making less than $250,000 a year.

Ironically, Obama’s “cap-and-trade” carbon tax might have the perverse effect of increasing, rather than reducing, greenhouse gas emissions. Cap-and-trade is a pernicious “form of tax farming.”

Toxic Asset Rip-Off

by Hans Bader on March 23, 2009 · 3 comments

in Bailout Watch, Deregulate to Stimulate, Economy, Features, Politics as Usual, Regulation, Stimulus to Nowhere, Zeitgeist

That’s how analysts describe the trillion-dollar toxic-asset buy-up program proposed this weekend by the Obama Administration: “the president is putting forth his idea to have the Treasury become the new AIG. In order to get hedge funds to buy up toxic debt, Obama is proposing that the Treasury provide loans up front and insurance against potential losses on the back end. It’s what Paul Krugman called ‘heads I win, tails the taxpayers lose.’ By the way, it may cost another $1 trillion.”

The Treasury Secretary claims taxpayers won’t lose a full trillion, because the assets aren’t as worthless as their current market prices suggest. But if that’s true, why does he continue to insist on federal accounting rules that force banks to value their assets at the current depressed market prices? Either the accounting rules are right — in which case taxpayers will end up losing a trillion dollars — or they are wrong, amplifying financial panics — in which case the rules should be repealed, so that banks, not taxpayers, will be able to take the risk of holding the assets. (If these accounting rules, known as “mark-to-market” accounting, had been in place in the late 1980s, “every major commercial bank would have collapsed,” wiping out the economy).

It’s not even clear that all these bailouts are needed. As William Seidman, the banking official who helped clean up the S&L Crisis as head of the RTC, notes, the government’s $170 billion AIG bailout was absurdly expensive and wasteful. “We paid off huge debts that AIG had in the swaps market, which we probably did not have to do. We bought a number of assets from AIG at high prices, which we probably did not have to do.”

That includes a huge unneeded windfall for the investment bank formerly headed by Treasury Secretary Paulson, Goldman Sachs, which received billions of dollars from taxpayers that it did not even need, through the AIG bailout. As James Piereson notes,

“Goldman wound up receiving $12.9 billion in December from AIG in an initial payout from the TARP money. Thus, taxpayer funds were used not so much to bail out AIG, but rather its “counterparties,” including Goldman and a dozen or so other major banks. Now, in an interview with the press on Friday, Goldman’s chief financial officer has declared that the company was never in jeopardy from a collapse of AIG — that it held some $7.5 billion in collateral against its AIG account and that it had hedged the remaining $2.5 billion in its net exposure using credit-default swaps with other parties. . .David Viniar, Goldman’s chief financial officer, insisted that the company would not have been damaged if AIG had been allowed to collapse. Even so, the company profited handsomely from the payout from AIG, courtesy of the American taxpayer. Goldman could not turn down the payout without damaging its shareholders, Mr. Viniar said. In other words, if the U.S. government — via AIG — was going to offer a gift, Goldman was not in a position to turn it down. Which raises the question: What then was the point of the AIG rescue? The claim by Paulson et al that a collapse of AIG would bring down the international financial system was entirely unsubstantiated. Congress passed the bailout bill under pressure from the financial authorities that they had to act to ‘save the system.’ It turns out that this was far from being true. The lesson from this is that everyone — most especially members of Congress — should look skeptically upon claims that this or that institution is ‘too big to fail’ or that a catastrophe awaits of a major financial institution is not bailed out.”

Politicians frequently claim the sky will fall if their proposals are not implemented, even when they know that is not true. Obama claimed the $800 billion stimulus package was needed to avert “disaster” and “irreversible decline.” But the Congressional Budget Office, controlled by his own Congressional allies, admitted that the stimulus package will shrink the economy over the long run, in reports released both before and after the bill’s passage.

While pushing through $8 trillion in bailouts, and trillions more in debt from massive budget increases, the Obama administration has ignored inexpensive possible remedies for the financial crisis like reform of “mark-to-market” accounting rules. Many commentators are now calling for relaxation of those rules in order to stem the financial crisis, including former FDIC Chairman William Isaac, Congressmen Ed Perlmutter (D-CO) and Paul Kanjorski (D-PA), the Wall Street Journal, John Berlau, Jeff Miller, Holman Jenkins, Newt Gingrich, and the Republican Study Committee