Community banks fail over technicality: Study
The so-called 'mark-to-market' rule, put in place for transparency, made some banks' finances appear more troubled than they really were when the housing crisis hit.
Since the banking crisis hit hard in 2008, Georgia has seen more than 80 banks go under. That’s more than any other state. Most have been small, community banks whose assets were tied to the housing market. But did those banks have to fail?
A new report from the University of West Georgia says in many cases, the answer is no. The reason so many did, the report finds, is because of an accounting rule called “mark-to-market,” which regulators put in place after the collapse of Enron.
Here’s how it works. Say you buy a house for $100,000. The economy tanks, and the value falls to $50,000. You keep paying on the hundred grand, but the bank must report on its books $50,000 -- the diminished fair market value of the asset.
“As the bottom fell out of the real estate market, with that rule in place, that has destroyed in an artificial way a lot of capital in banks,” says Danny Jett of the Georgia think tank Main Street Solutions.
The non-profit funded the University of West Georgia study looking at the effect of the mark-to-market rule on small banks.
“Context matters,” says Dr. Joey Smith of the University of West Georgia’s Richards College of Business. He found the mark-to-market rule doesn’t always paint an accurate picture of a bank’s solvency.
“You have to take into consideration what’s happening around the bank, and other banks, because it’s one big relationship,” he says.
The study’s findings show that in the recent crisis, banks had to unload loans that were bad on paper, although they may have been paid as agreed upon. And that created a snowball effect.
The rule was revised in 2009, but Smith says if mark-to-market isn’t revisited, we’re likely to see more community banks collapse in a future crisis.