Mark-to-market accounting did not cause the financial crisis. It made the picture clearer.
Betsy Hansen wrote that in July 2009. Federal Accounting Standard 157 requires banks, securities firms, and insurers to reassess the value of their securities periodically so financial statements reflect current asset values. The rule became mandatory for all banks, securities firms, and insurance entities with fiscal years beginning after November 15, 2007.
Steve Forbes said the SEC should have rescinded the rule immediately because it forces a bank to show impairment from a loss it hasn’t taken yet. John Mauldin quoted Gary Townsend, a former federal bank regulator: mark-to-market creates a powerful negative feedback loop. Actual or imputed FAS 157-related losses weaken capital ratios. That undermines confidence in the financial system. The economy weakens. Loan pricing pressure rises. More FAS 157 losses follow.
The Wall Street Journal claimed the accounting issue sits at the heart of the financial crisis. That is an overly simplistic explanation. It forgets the myriad additional government interventions that deserve condemnation.
The FASB runs at a snail’s pace. On February 18, it said it didn’t expect to complete its examination of mark-to-market standards until late June. Congress hounded. The FASB rushed. The proposed staff position FSP FAS 157-e arrived April 2, 2009, after a 15-day comment period.
The reform let financial institutions mark assets to market prices only in a steady market. When markets are inactive or turbulent, the rules need not be followed. Banks may use their own in-house valuation models. The probability those models give a more favorable valuation than the market? Pretty high.
James Chanos chairs the Coalition of Private Investment Companies. He said gutting MTM rules will further reduce investors’ trust in financial statements. Private capital – desperately needed in securities markets – becomes even scarcer.
Bank balance sheets are in terrible condition. No one disputes that fact. Is it because banks must mark assets to current market prices? Or because, thanks to unsound inflationary policies of the Fed, banks became seriously overleveraged in the first place? Hansen stands in the overleveraged camp.
Banks overexpanded money and credit. That caused this crisis. Sound money and banking practices are the cure.
Hansen’s argument rests on a distinction that gets lost in the noise: the rule reveals the rot; it does not create it. FAS 157 forces transparency. When the market says an asset is worth less, the balance sheet must reflect that. The alternative – letting banks value assets at whatever they wish – produces the opacity that makes crises worse.
The FASB’s April reform was a surrender to political pressure. Congress wanted action. The board delivered a loophole: mark to market only when the market behaves. When it doesn’t, use your own models. The incentive structure is obvious. Banks will not mark down voluntarily.
Chanos warned that obfuscation erodes trust. Without trust, private capital flees. The very institutions demanding relief from mark-to-market rules end up starved for funding. The SEC, armed with statutory authority under the 1934 Act, did nothing. It watched the FASB flail.
The deeper problem predates FAS 157. The Fed’s inflationary policies fueled an overexpansion of money and credit. Banks leveraged up. When the music stopped, the assets weren’t there. The accounting rule just turned on the lights.
Sources
- The Mark-to-Market Accounting Issue Is a Scapegoat! – LewRockwell
- Fair Value Accounting Fraud: New Global Risks And Detection Techniques [PDF] [20d578cknhi0]
