Mark-to-Market: Numbers Don’t Add Up

The Financial Accounting Standards Board (FASB), an independent agency that sets business accounting rules, announced today an accounting change that may temporarily boost markets but in the long run may bring more harm than good. That change subverts mark-to-market accounting rules, which held that the price of a mortgage security, for example, reflect current market value rather than what someone hopes to get for it in the future. In place of these rules, bankers will have the discretion not to disclose declining values in such assets on their income statements, thus allowing them not to write down toxic assets. As a result, banks will no longer, it is claimed, have to hoard capital to offset bad loans, thus helping to thaw frozen credit markets.

The problem with the change in rules is that allowing banks in effect to hide their bad loans makes transparency a bad joke. Lack of transparency in accounting practices helped to cause the savings and loan disaster of the 1980s. A report in McClatchy News today highlights the problem:

During the S&L crisis, government regulators initially eased federal accounting rules for troubled S&Ls, which hid their negative worth and allowed them to make even worse decisions that led to their collapse and an expensive federal rescue.

Last month, members of Congress and banking interests, according to today’s New York Times, pressured the FASB to change the rule and by extension blamed much of the current financial crisis on mark-to-market rules. But it may have been a lack of mark-to-market rules that enabled the housing bubble to expand, allowing banks to overvalue undeserving assets. It seems that FASB bowed to that political pressure in contravention of its own mission:

Serving the investment public through transparent information resulting from high quality reporting standards, developed in an independent, private sector, open due process.

As a commentator on CNBC put it today, this accounting solution is like giving the fire hoses to the arsonists. What’s likely to happen won’t put out any fires and may, in fact, increase their intensity.

The Center Isn’t Holding

The U.S. may not be close to loosing mere anarchy upon the world — yet — , but how much time do we have left before the chaos begins? If last week’s financial news doesn’t impel us closer to a national (global?) breakdown, I don’t know what does. The country is still in a crisis of leadership, from the executive and legislative branches of government to the offices of the corporate community. The more things stay the same in Washington and Wall St., with Democratic arrogance, Republican recalcitrance,  and business tone-deafness, the more leaders will discover that a still divided public is fast becoming ungovernable.

The indignation unleashed by news of A.I.G.’s payment of bonuses to executives who created the derivatives that caused the problem has swamped the message. Administration spokesmen’s inability to explain why the bonuses were inserted into stimulus package legislation has eroded confidence in the administration. Congress, covering its own tracks in the debacle, has proposed a 90% tax on the bonuses. Few take their or the Administration’s espousals of outrage as sincere, and no one understands that if the government demands autoworkers to renogotiate contracts to bail out their firms, why won’t it demand the same of A.I.G. and troubled banks receiving goverment dole?

And all of this takes place on the eve of Treasury Secretary Geithner’s announcement of plans to remove troubled assets from the big banks’ balance sheets, the core problem of the credit freeze. Temporary nationalization of distressed banks that pose a systemic risk seems to have lost its place at the table. Paul Krugman this morning despairs over the details of the plan, suggesting that the Obama administration may be squandering its political capital in a scheme to inflate the prices of toxic assets with taxpayer money to bring in private investment. “But,” says Krugman, “the Geithner scheme would offer a one-way bet: if asset values go up, the investors profit, but if they go down, the investors can walk away from their debt.” Krugman may not have all the details of the plan, but his essential point is that the plan can’t work. If it doesn’t, what happens then?