Marketplace Scratch Pad

This little piggy went mark-to-market

Scott Jagow Apr 2, 2009

Stocks are having a fat rally today mainly because of a change in accounting rules. The Financial Accounting Standards Board has relaxed mark-to-market so that banks can use “significant judgment” in determining the value of certain assets. Is this fairy tale accounting or a necessary bank savior?

The change certainly allows banks to avoid some of the nasty write downs that have polluted their books. And it’s likely to increase bank stock prices because their profits will look much better. In fact, they might look better for this quarter, since the rules are being applied retroactively for January, February and March.

The argument for relaxing the rules, as laid out by reporter Amy Scott on the Marketplace Morning Report:

Banks have to report the value of the stocks and bonds on their books based on what investors might pay for them. Right now, they’re not paying much for anything. So consultant William Isaac says the accounting rule has forced banks to mark even healthy assets way down.

But Wharton accounting professor Brian J. Bushee doesn’t buy that at all. From a Wharton school article published yesterday:

Changing accounting rules to accommodate the banks would be like changing the scoring system for tennis, he suggests. “It wouldn’t make you a better tennis player. Changing how we keep score — what these assets are worth — won’t change the problem…. In a sense, that’s what [the banks] are asking investors to do — to say, ‘Let’s use these four-year-old values, not what things are currently worth.”

Wharton real estate professor Susan Wachter says reflecting the current market value of assets, even when there isn’t really a market, is essential:

… because investors who could pump capital into the banks will be reluctant to do so if they think accounting tricks make banks look healthier than they are. Easing the mark-to-market requirement, she says, “is a road to a long and sustained recession.”

Amy Scott also asked whether easing mark-to-market will undermine the Treasury’s public-private plan to have investors buy toxic assets. If the assets are priced higher, will banks have any incentive to sell them?

Jack Ciesielski publishes the Analyst’s Accounting Observer. He says when banks mark down their securities, they have to raise more capital to insure against potential losses. If suddenly they don’t have to raise that cash, Ciesielski says they may decide to hold onto the assets.

Jack Ciesielski: Why would you take the drastic step of selling them now, if you think you can just raise your capital or keep your capital intact with the stroke of a pen?

Perhaps banks can sell the worst assets if they’re able to price healthier ones higher. I don’t know. I understand the incredible stress of some of these assets, and that every day, banks are going under. But it seems to me, allowing them to make up values is like kids playing with imaginary friends.

Or putting lipstick on a pig.

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