"Mark-to-market" accounting fight goes down to the wire

With the House vote looming on the financial-system bailout plan, proponents of "mark-to-market" accounting rules are trying to beat back efforts in Congress to suspend the rules as part of the bailout.

The head of the Financial Accounting Foundation, which oversees the Financial Accounting Standards Board, on Thursday warned against "political interference" with accounting rules -- although it’s clear this issue already has become seriously politicized.

"We believe that once Congress starts setting accounting standards through its political process, the integrity of U.S. accounting standard-setting and the credibility of U.S. financial reporting will be dangerously compromised," wrote Robert Denham in a letter to House Financial Services Committee Chairman Barney Frank (D-Mass.).

Denham is a partner at L.A.-based law firm Munger, Tolles & Olson and a longtime advisor to billionaire Warren Buffett.

The people he really needs to reach are the conservative House Republicans who have been agitating to suspend mark-to-market standards.

Mark-to-market accounting requires financial institutions to value securities on their books at current market prices. Many bankers assert that the rules have unfairly ravaged the industry’s balance sheets because, they say, market values of mortgage-related securities are unrealistically low, reflecting the massive uncertainty over the housing market.

They have a point, of course. The market for mortgage paper is a mess, thanks to the Wall Street geniuses who created some of the most complex securities ever to be foisted on investors. Still, accounting standards already give banks latitude in figuring what hard-to-value assets are worth. The FASB and the SEC provided more latitude in rule "clarifications" on Tuesday, in an obvious bid to head off more interference from Congress.

Some House Republicans, and a few Democrats, want to suspend mark-to-market accounting altogether. That would allow banks to affix much higher values to mortgage debt.

Accounting purists say that would lead to fantasyland valuations, misleading investors.

"Suspending the proper accounting of this paper is the refuge of cowards," financial blogger Barry Ritholtz wrote in a strong defense of mark-to-market on Wednesday. "It reflects a refusal to admit the original error, it hides the mistake, and it misleads shareholders. I find it to be a totally unacceptable solution to the current crisis."

The language in the bailout bill passed by the Senate on Wednesday gives the SEC the authority to suspend mark-to-market accounting for any type of security, but doesn’t require the agency to act. That was the same watered-down wording that was in the first House bailout bill -- wording that some anti-mark-to-market conservatives cited as one of the key reasons they voted against the bill.

SEC Chairman Christopher Cox is under heavy pressure from both sides. He’s supposed to meet on Friday with top executives of major accounting firms, Bloomberg News reported.

On Wednesday, groups representing the accountants, large pension funds and chartered financial analysts issued a joint statement declaring their unequivocal opposition to "any suspension of mark-to-market" accounting.

Photo: Robert Denham. Credit: Munger, Tolles & Olson

Comments

[VW]

The Mark-to-Market accounting rule is the best way investors have to determine the security of their investment...

Think of the Mark-to-Market rule as a credit rating for banks, many bad investments = Lower credit rating...

[JCK]

I disagree. MTM is based on the premise that the price set in the market reflects the "fair" value. It works in a "normal" market but not in a market that is half frozen due to panic and credit crunch.

Let's see the worst assets right now: subprime mortgages and securities backed by subprime mortgages. There's almost no market for these assets now. What should the MTM value be? Financial institutions hold these securities are required to write them down to fire-sale prices. But has anyone considered the fact that an 18% or 19% delinquency in subprime mortgages means over 80% of the mortgages that back these securities are still performing? Performing mortgages have values. They yield consistant cash inflows. And as long as the collaterals back these securities have value, the securities should have value too.

Forcing financial institutions to record unrealized losses based on an unrealistic market price is pushing a lot of financial institutions to the brink because they have to raise substantial capital to offset these unrealized losses to meet the capital requirement. It deincentizes these financial institutions to lend out money and hence, a global credit crunch.

I'm a CPA and I'm all for transparency. But I also work in the finance industry and know the business side. The damage MTM is causing is very real. The FASB needs to get out of the ivory tower and get back to the basic about value.

[Ransome]

If this is even considered there would need to be transparency as in open book accounting. The valuations would need to be justified and investors and regulators could compare different valuations of similar securities. In a way you might be able to come to an agreement of value even when the market is frozen. These securities are producing a return right now and there is historical data indicating trends.

[Robert Lee]

Didn't Enron abuse Mark-to-Market accounting rules, which lead to their over valuation and eventual collapse?

Have we not learned anything for our recent history?

It appears we are going to turn around and let these institutions value, at will, the vary thing that is bringing the value of their company down.

What would keep them from over valuing these mortgage backed securities and causing more problems down the road?

[Doug in Toronto]

I don't think the "accountants, large pension funds and chartered financial analysts " have any right to complain after American tax dollars are so graciously handed out to get them out of the mess they helped to create. Don't look a gift billion or three in the mouth, unless you want to rile voters up so much that the the next set of rule changes make these look tame by comparison.

[jay weiss]

is it true that marked to market only works when the market is working? thank you.

[Clayton]

Let me put it this way.

If 2 banks trade a mortgage the day everyone has to mark to market and set the price at $1 billion over it's value, lets say for a $100k house, all banks would then be able to revalue their $100k mortgages up to $1 billion. This may mark up their asset side of balance sheet by a trillion $+.

Does that bank now have more money available to lend? Absolutely not! This goes the other way, too.

A bank's ability to LEND MONEY is (should be) completely divorced the "market prices" of assets they hold. Right now banks have BILLIONS in cash that they are NOT ALLOWED TO LEND due to their assets being artificially marked down.

Literally, banks have money available to lend and the bad government regulation is forcing them to not lend.

This is overregulation destroying us.

If you want mark to market accounting for the sake of comparing one bank to another, fine. But it should have absolutely no bearing on whether or not a bank can lend.

You want transparency? Require banks to disclose all loans on their books:
Loan1 = $100k principal @ 6% interest with a credit rating of 720
Loan2 = $236k principal @ 6.5% interest with a credit rating of 690

And so on.

You can get transparency without destroying the industry.

Mark to market is a farce and the cause of this problem more than any other single issue.

[A L Flanagan]

"the integrity of U.S. accounting standard-setting and the credibility of U.S. financial reporting will be dangerously compromised," wrote Robert Denham"

While I agree with Denham's point, I have to break some bad news to him: you can't compromise and image that's already been destroyed. Too many accountants have been much too happy to go along with every crazy new gimmick that comes along.

[mwj]

I knew years ago when the cost of housing tripled way beyond their true value that M-T-M would cause a dire financial crisis. Lenders lined their pockets at the expense of us all, and we bailed them out again. They'll be back in the future wanting more.

[J. Crosby]

Accountants have been the scapegoat for a long time now when an organization goes down in flames. Just like in Enron, it's usually the conspiracy of many individuals to perform the acts. I guess if you just need one group to blame everything on though................

[JW]

It is disingenuous to identify Barry Ritholtz as only "a financial blogger." I've enjoyed reading him in recent months, but you might want to consider the extent to which he would benefit financially if the stocks of banks, insurance companies etc. were to decline sharply or the underlying companies go bankrupt, as that could influence his beliefs.