The return of Mark to Myth?

It looks like the Senate is attempting to allow the banks to sweep their problems under a rug.  A article this evening says “an accounting regulation that some bankers and lawmakers complain is a key contributor to the financial crisis might need to be temporarily changed or restricted. The rule, known as mark-to-market, requires corporations to adjust the value of their assets four times a year to reflect the fair market price.”

In other words, this accounting rule (known as FAS 157) requires banks to state the actual value of the assets they are claiming.  Before this rule took effect, most banks used a “mark to model” method (many refer to this model as “Mark to Myth), which pretty much allowed them to make up a value and claim it as an asset.  You can read about FAS 157 on the FASB site here.

Many are blaming the financial meltdown on FAS 157, because it became part of Generally Accepted Accounting Practices (GAAP) in November, 2007, which happened to be the same time we started seeing the huge write-downs.  But FAS 157 isn’t the problem – the crappy mortgage derivatives the banks are claiming as assets are the problem.

Before FAS 157, the banks could pretty much claim any value they wanted for the mortgages and derivatives they owned.  Investors didn’t have a clue regarding the real value.  Mark to Market changed that.  Now the banks had to own up to the shenanigans.  No longer could they claim a $500,000 mortgage was worth $500,000 if the borrower was late or in default.  They had to value that mortgage at what it was really worth on the open market.

The problem is that no one knows what anything is really worth until someone buys it and establishes a price.  And there was (and still isn’t for the most part) anyone who wanted to buy a bad mortgage for anywhere near face value.  So the banks didn’t like FAS 157, because they had to write down the value of their crappy assets to reflect the real world.

And when they wrote down these assets, it increased their leverage ratios.  So when the government required them to have $1 in assets for every $12 they had loaned out (the standard until Bush changed it in 2004) suddenly they were under-capitalized.

They were caught between a rock and a hard place.  They either needed to raise more capital, or call in their loans.  They really had no choice – they couldn’t call in their loans because the loans were made to other banks (who counted them as assets and had borrowed against them) so most banks couldn’t maintain their required capital ratio of 33-1 (which is what the Bush administration changed it to – read about that part of this mess here.) so they had to raise capital.

That’s fine and dandy, but who would give an inadequately capitalized bank more money?  Pretty much no one.  Which is also as it should be.

So here’s what should have happened.  The banks who made the crappy loans, the banks who bought those crappy loans from the original bank, the rating agencies who rated the crappy mortgages and derivatives as investment grade, the insurers (mainly MBIA and AMBAC) who insured the crappy mortgages and derivatives against default, and those who purchased stock or bonds from any of these companies should all lose money.  Most would go broke and disappear.  But someone would buy those crappy assets at the bankruptcy sale (thus establishing a true market value for them) and use that true market value as an asset.

And it would truly be an asset at that point, the write-down having taken place when the original company went bankrupt.  But our idiot government could let that happen.  So we starting re-capitalizing banks (and others like GMAC and GE) with tax dollars.  Which obviously hasn’t worked very well because they still want more money.

These write-downs will happen someday – the crappy mortgages are still crappy and won’t be paid back – so all we’re doing with the trillions in bailouts is delaying the inevitable.  And causing those who saved their money and didn’t over-leverage to go broke in the process.

Changing or eliminating the mark to market accounting requirement doesn’t actually change a damn thing – it simply allows the financial institutions to sweep their problems under a rug.  The problems are still there, but everyone is allowed to pretend that they’ve gone away by claiming they’re still worth just as much as they were two years ago.




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  1. […] wrote about this last month, and it’s been in the news agin this past week, because there’s once again […]

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