12/15/2008

The SEC (very) partially solves the mark-to-market accounting rule problems

Personally, it would have made a lot more sense to completely scrape these accounting regulations. The "does not exist" phrase is too restrictive, as few markets are completely absent. This from the Washington Post.

The Securities and Exchange Commission and the Financial Accounting Standards Board have just made an announcement that, dry as it sounds, may mean a great deal: "When an active market for a security does not exist, the use of management estimates that incorporate current market participant expectations of future cash flows, and include appropriate risk premiums, is acceptable." . . .

Simply put, mark-to-market accounting requires companies to set the value for the assets they own at the price they could fetch on the open market right now. The prices must be "marked to market;" hence the phrase.

What does that have to do with the current crisis? The root problem now is that financial institutions have been caught holding value-less, or "toxic," assets on their books, such as the mortgage-backed securities based on sub-prime mortgages that have defaulted.

The government believes that those assets will be worth something soon -- that's why they want to buy them in the $700 billion Wall Street rescue plan. But under mark-to-market rules currently required, they are worth almost nothing, threatening those who hold them with insolvency. . . .

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2 Comments:

Blogger Angela said...

I majored in accounting, not economics, but I usually can keep a decent pace with the theories the experts put forth. Having said that, I still do not understand the rationale behind the call to rescind the mark to market rule.

Allowing companies to overstate asset value just can't be the best way to prepare balance sheets.

I mean, wasn't the whole point of the rule to force companies to show the real market value of those assets? If the market value is currently zero, then footnote it.

In an environment that is calling for better regulation and more oversight, repealing mark to market seems to be a step in the wrong direction if transparency is indeed the goal.

On the other hand, if we're just looking for an excuse to create more credit, it makes all the sense in the world.

12/15/2008 8:30 AM  
Blogger David said...

Doesn't your argument against mark-to-market accounting somewhat contradict your argument regarding the signal sent by GM's bond rates? In the case of sub-prime mortgages, you are arguing that the current market demand is not necessarily a valid indicator of future cash flows but are arguing the exact opposite in the case of GM. The interest rate on GM bonds can shoot up to 50% to compensate for investor risk whereas the rate of return on mortgages are essentially fixed and thus demand simply drops to zero if perceived risk exceeds that rate. It seems like essentially the same market force -- fear of default -- that is driving both phenomena, along with risk-weighted capital requirements that prevent firms from investing in either sub-primes or GM bonds.

12/15/2008 7:52 PM  

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