'Mark to market' accounting should stay, SEC report says

Bankers who've been seeking Congress’ help to suspend "mark to market" accounting rules lost a battle today: The staff of the Securities and Exchange Commission recommended in a report that mark-to-market rules should be maintained, although "improved."

The report had been ordered up by Congress in October as part of the financial-system bailout.

The banking industry asserts that mark-to-market, or fair-value, accounting worsened the financial crisis. The rules require require financial institutions to value securities on their books at current market prices, even if the securities don't mature for many years.

Bankers say that has unfairly ravaged their balance sheets because, they say, market values of mortgage-related securities have been unrealistically depressed, reflecting the massive uncertainty over the housing market.

Some House Republicans, and a few Democrats, have wanted to suspend mark-to-market accounting altogether. That would allow banks to affix much higher values to mortgage debt. As I’ve noted previously, accounting purists say that would lead to fantasyland valuations, misleading investors.

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

The new SEC report, compiled by the agency’s office of the chief accountant and division of corporation finance, makes the case that "fair value accounting did not appear to play a meaningful role in the bank failures that occurred in 2008." Instead, "Bank failures in the U.S. appeared to be the result of growing probable credit losses, concerns about asset quality, and in certain cases, eroding lender and investor confidence," the SEC says in a summary.

Of course, investor confidence was eroded in large part by the massive write-downs banks took on mortgage-related securities.

The SEC report recommends improving mark-to-market rules, including via "the development of additional guidance for determining fair value of investments in inactive markets," such as in situations where market prices are not readily available.

That described the market for mortgage securities for much of this year, as buyers evaporated.

Charles Mulford, an accounting professor at the Georgia Institute of Technology, told Bloomberg News that the SEC report recommends "no significant change in current accounting, and that's a good thing. It's not changing how we're doing things, just clarifying them."

A summary of the SEC report is here. The full report is here.

-- Tom Petruno

Comments

[Trudy Self]

Did you notice that no one complained about mark to market when it allowed financial institutions and GSEs to mark assets up and pay outrageous dividends as Fannie and Freddie did for years? Just think of the margin of protection (cash) that would have given them when asset valuations went down if it hadn't all been paid out.

[JS]

Mark to market must remain, as it's one of the few real protections against the liars, theives and cheats on Wall St. Note - not all are liars, theives and cheats. But almost all of the ones getting $40 mil a year to halve the stock price. Sanity and transparency must prevail over greed and avarice.

[Ralph L. Seifer]

If the public supports Mark-to-Market on the theory that it is realistic and conveys meaningful, informed data to investors and depositors, you "can take it to the bank" that the financial industry and similar large contributors
will oppose it, and Congress can be relied upon to respond to its financial supporters, not to the electorate. Ralph L. Seifer, Long Beach

[Joseph]

The SEC and the Accounting firms would like us all to believe that clarifying accounting rules will help us understand the financial statements, and thus, the markets. Mark-to-market, in its simplest form, means that values of assets on a firm's balance sheet should be reflective of existing market conditions.

The information we really need is whether the firm in question has the financial strength to survive, in spite of the mark-downs in asset values. If the firm is running out of cash, and must liquidate its assets to meet debt obligations, then the mark-to-market values are critical. On the other hand, if the firm has an event horizon well into the years with regard to debt maturity, then those assets could presumably regain their values without a firesale.

All we need is for the accountants to tell us those circumstances in plain English. Perhaps they should read Warren Buffet's letter to the Berkshire Hathawasy shareholders.

Mr. Buffet liked to call his method of buying and valuing assets as a "margin of safety." It's a much easier way to look at the world than through complex accounting rules.

[Mark]

Mark-to-market accounting and not fundimental value declines caused a huge portion of this economic crisis by adding too much volatility! Tying corporate income directly to trader whims is a hugh mistake and resulted in to high of high's and too low or low's. A couple of years ago, loans were way over valued as the general investment market was over-valued (markets are irrational as exhuberance and fear stampede values), artifically inflating corporate profits. Now, loans are priced at levels that are impossibly low due to fear. In order for today's pricing to be justified, 100% of all mortgages would have to go into default in the next year and only recovered 80% of value. This would mean that every property in the US would have to go bad and sell to 70 cents on the dollar. This is not realistic, and will not happen. Mark to market accounting has forced banks to write the value of their holdings down to these levels though, destroying their ability to lend further due to capital requirements, which has directly led to the depth of this recession! Accountants are nit-pickers, and just worried about creating as many accounting jobs as possible!!!

[mr.bilko]

Mark to market is like homeowners' equity and holding stocks.

Timeline: July 2007
Neighbor: I'm a millionaire. Houses in this zip code are selling for $925K
Me: When did you buy?
Neighbor: 1995, paid $300K
Me: You are not a millionaire. You only get the $925K if you sell it.

Timeline: November 2008
Neighbor: I lost $325K in 16 months. Houses in this zip code went from $925K down to $600K.
Me: You didn't lose anything. Your loss in equity is on paper only. Your real worth hasn't changed since no assets changed hands.

And, in a nutshell, this is the problem with mark to market. During asset bubbles, i.e. 2003 to mid-2007, mark to market creates unrealized gains and during bubble busts, mid-2007 to current, it creates unrealized losses.