Sunday Musings: Mark-To-Market Changes

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Hat tip to reader Richard for pointing to “New Mark-To-Market Rules Coming.” Here are some highlights:

The House Financial Services Committee, led by Rep. Paul Kanjorski (D-PA), yesterday (Thursday) successfully browbeat the Financial Accounting Standards Board (FASB) into coming up with modifications of the mark-to-market rules for valuing bank assets. Wall Street, which over the last 10 years has invested over $5 billion in lobbying and campaign contributions, is seeing a nice payoff on their investment. Investors, not so much.

The claim is made that these “toxic” assets are not being truly valued by the market. Why would that be the case? Is this some little obscure asset that nobody has ever heard of? Hardly – there has been endless talk about them for months, not just in the financial press, but in the general press as well.

The reason that these markets have dried up is not that there are no buyers. It is that the current holders cannot afford to sell. This is exactly like in the early days of the bursting of the housing bubble. In late 2006 and early 2007, inventories of houses for sale started to build up, and the number of houses sold started to fall sharply, yet the median price of an existing house held up very nicely.

The sellers were trying to hold out for what their house was “really worth” based on what the house down the street sold for six months earlier. So they held out, and now they really can’t afford to sell, since to do so would require them to bring there check book to the closing, and they don’t have anywhere close to that amount in the account. Does that fact make the house “really worth more”? Of course not!

Thus the idea is to let the banks make up the valuation for these assets. Oh sure – they will have some fancy black box model showing how much they are “really worth.” But anyone with three hours of experience with Excel can make up a spreadsheet that gets the answers they want if they manipulate the numbers and the assumptions that go into the spreadsheet.

There is a term for knowingly publishing financial statements with incorrect values in them, and that term is “securities fraud.” The very foundation of capitalism is that the “real value” for something is that which a willing buyer and a willing seller can mutually agree upon. That, folks, is the market price. That is the price at which these securities should be valued.

Supposedly, suspending mark-to-market rules is going to restore confidence in the banking system. This is nonsense. Why would you buy a bank, when it clearly says: “This book value belongs on the fiction shelf”! If a bank is insolvent, it should be taken into receivership. We do it all the time with small banks – 25 times it happened last year, and so far it has happened 19 times this year.

Taking over the big banks, cleaning them up and then selling them off as quickly as possible has worked in the past, most notably in Sweden. We should go that route, rather than legitimizing securities fraud.

[Emphasis added]

As the author pointed out, changing mark-to-market accounting will be the equivalent of fraud. We all have to live with mark-to-market rules whether we realize it or not. If you sell anything in the open market place, be it via a garage sale, an ad in the paper to get rid of your old car or a vacant lot, a final price is established by an agreement between a willing buyer and a willing seller.

So why should banks be exempt? For the simple reason that, as many bloggers have posted before, mark to market accounting would render them insolvent. What arrogance. You make bad business decisions and instead of being punished, you simply change the law in your favor and come up with fancy models supporting your view point.

To demonstrate, I am thinking of selling one of my assets, which is a 3-year old Jeep Laredo, for $20,000. The problem I am having is that most buyers think the car is worth only $12,000. Adopting banking terminology, I insist that my pricing model is correct, and I firmly believe that they simply don’t understand this asset.

How is that for arrogance?

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Comments 3

  1. I know I’ve posted this before but it bears repeating; from Jim Rogers.

    “What is outrageous economically and is outrageous morally is that normally in times like this, people who are competent and who saw it coming and who kept their powder dry go and take over the assets from the incompetent,” he said. “What’s happening this time is that the government is taking the assets from the competent people and giving them to the incompetent people and saying, now you can compete with the competent people. It is horrible economics.”


  2. Under generally accepted accounting principles, assets are valued at actual cost minus depreciation. However, inventory can be valued at cost or market whichever is lower.

    Book value is not in any way a measure of what you can sell an asset for in the market.

    Marking to market was probably designed to mark UP assets when housing values were rising, but now that they are falling, they want to change the rules.

  3. ULLIE:
    Just a comment for your blog! I think it was Maggie Thatcher who said (maybe close to her quote) which said: “the biggest problem with ‘socialism’ is that you eventually run out of other people’s money”. I think that pretty much sums up the current ‘Obamanomics’!
    Have a nice tomorrow!

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