mark-to-market accounting

Steve Forbes: How Capitalism Will Save Us

by Ivan Osorio on January 19, 2010 · 2 comments

in Deregulate to Stimulate, Economy

Steve Forbes gave a very good talk today, on the topic of his new book (co-authored with Elizabeth Ames), How Capitalism Will Save Us: Why Free People and Free Markets Are the Best Answer in Today’s Economy. Just as importantly, though, he also explained how it was the undermining of capitalism by persistent government intervention that brought us to the current financial crisis. He singled out a few specific reasons.

First, the Federal Reserve kept interest rates too low for too long. This created what Forbes termed, the “fuel” for the housing bubble, which would not have occurred — or at least not grown into the enormous problem it did — had the Fed not flooded the economy with “liquidity.” I have long believed this, and several pundits have argued in favor of this view, but it was good seeing someone couch the problem of excess in the money supply in the context of a larger pattern of government intervention.  I especially liked his analogy of currency to time: If the number of minutes in an hour were to constantly change, we’d soon see derivatives and hedging strategies for time, just to keep track of how many hours we’ve worked.

Second, the bubble was further exacerbated by the moral hazard created by the guarantee of unnecessarily risky loans afforded by Fannie Mae and Freddie Mac.

Third, mark-to-market accounting forced companies to value their assets as if they were day-traders. This inflated asset values at the top of the market, and depressed them when the market went down. This effect was so extreme that it created paper losses for firms that had a positive cash flow.

So how to move away from these problems toward a more prosperous future? Quite simply, government should get out of the way of the productive sector. Specifically, he said, government should focus on securing the rule of law and sound money, as well as facilitating the ease of doing business by removing barriers to entrepreneurs starting new business.  (Thanks to Myron Ebell for his input in this post.)

For more on mark-to-market accounting, see here.

For more on Fannie and Freddie, see here (page 4).

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.”