Down With "Mark to Market"?

Well, the Financial Accounting Standards Board has just messed up, big time. One of the things driving the stock market's strong gains today is this story, which has the FASB approving a change to the "mark to market" accounting rules that will now only require banks to carry troubled assets on their books at what the prices of such assets would be in an "orderly sale", as opposed to at today's current market prices which are considerably depressed as compared to the values the banks are holding such assets on their books. This is crucial to the banking sector in this country, because the need to continually mark down their troubled asset portfolios to their current values is exactly what has our nation's banks recording billions and billions and billions of losses every single quarter for most of the past two years, and what many sector analysts and market pundits believe still represents another trillion dollars or more of expected writedowns in future quarters before the credit crisis is truly behind us.

At first blush, this change may seem like a fair one, at least conceptually. Why force the banks to write down (and thus record losses related to) the value of their asset portfolios to their current "distressed" levels, if the current environment does not reflect an "orderly" market where a more respectable price by historical standards may be fetched by these asset pools? That makes perfect, logical sense, right? Wrong, for at least two key reasons, and don't let the banks convince you otherwise.

First, it's not like the current "distressed" market for these securitized pools of assets is some kind of an artificial market. It is a real market, and the prices to which many of the big banks have been marking down their distressed mortgage portfolios represent real, actual sales of comparable pools of loans made recently in arms' length transactions between two actual parties, an actual buyer of the loans and an actual seller. In other words, although the market for such assets is clearly in a significant shambles compared to where this market was just a couple of years ago, the current comparable sales reflect where the market for the values of those assets truly is right now. The whole idea of course is that the banks should have to report their assets based on their real-time, real-life values, not the values the banks wish these assets were at, and not the values they are being recorded at on the banks' books, which in many cases may be several years old and completely out of date. So, to the extent that the true, current value of these distressed assets is lower than it was a year ago, two years ago or relative to any period of time, then in my view that is the correct value to which banks' assets ought to be marked at this point in time. If, in the near (or distant) future, the market for securitized assets picks up significantly, then at that time I would suggest the banks be permitted to recognize those corresponding gains in their mortgage portfolio values. This is good because, if the market for these securitized assets never actually picks up much from current levels, then we will have had our banks marking these assets at their "correct" values from as soon as the market adjusted itself downward with respect to these assets.

The second reason that allowing the banks to mark their mortgage assets down to "orderly" sales prices is a very poor idea is that once again it puts the banks in control of determining subjectively how much these assets are worth. And need I remind you of where that whole situation got us last time? Requiring the banks to use objective, actual sales of comparable pools of assets actually made in the market to value their own portfolios keeps the whole system honest, and it takes much of the subjectivity out of the process, thereby promoting accurate valuations for our country's banks. Allowing the banks, however, to determine (somehow) what the prices of these assets would be in an "orderly market" -- whateverthefuck that means -- will simply give the banks the freedom to continue not to mark their troubled assets down to their realistic, current levels. This will ensure that we do not have an accurate picture of the health of our banks, and will distort capital ratios, making them look far better and the underlying banks therefore far healthier than they actually are. Is that a good thing?

And need I remind you, nobody seeks or sought to enforce this new mark to market system on the banks when they kept marking up their ridiculous mortgage portfolios from 2001-2007, did they? Where was the FASB and congress and shareholders clamoring then for the banks to only carry these assets at the prices they would fetch in an "orderly market", thus at much lower levels than what we now all know was a redonkulous glut of credit and not actually "orderly" or sustainable by any measure? Nowhere, of course. Changing this mark to market rule now is only being done to help beaten-down banks to procrastinate a little longer in taking the rest of the trillion dollars of writedowns that they need to take to get their books trued up to the current reality. And this is particularly important in the banking sector, because as I have mentioned here previously, the level of capital that banks are required to keep on hand is typically calculated as a ratio of the bank's total capital to its total assets on hand. Allowing banks therefore to inflate the value of their current assets by using figures that are subjective and significantly higher than their actual current values will simply ensure that the banking system in this country not only stays weak -- with banks not having adequate capital on hand to withstand further shocks to the economy -- but also that it will continue to paint an unrealistic and overly rosy picture of the health of those banks, giving the impression of health when in reality the truth is far from it.

President Obama was right when he said this is the time to end the Era of Irresponsibility. Easing mark to market rules to allow banks to decide for themselves what an "orderly market" price for their beat-down asset portfolios would be is tantamount to a license to lie, and that's exactly what they'll do. They already did it, even when they weren't expressly allowed to by the FASB, which is what got them all into this huge mess of writedowns in the first place. Allowing the banks to lie to themselves, their shareholders, their customers and to the rest of the world in overstating their financial health relative to the current free market, unfortunately, is going to lead us to the direct opposite of the President's stated goal.