Mr. Forbes, Mark My House to Market
It's really quite practical to blame financial crises on accountants: they're generally anonymous and boring, they're always sifting through receipts, and they can create money out of thin air if they want to. But even better, it seems, is blaming President Obama's accounting practices.
In this spirit, Steve Forbes took to the Wall Street Journal's op-ed page on Saturday to argue that "mark-to-market" accounting rules - specifically (stay with me, please!) FASB rule 157 - caused our current financial crisis. You see, mark-to-market rules require that, as Mr. Forbes notes, "financial institutions...adjust their balance sheets...when the market value of the financial assets they hold goes up or down."
In essence, such rules require balance sheets to reflect what an asset would be worth if a firm tried to sell it right now. The problem, of course, is that markets for lots of "troubled" assets simply don't exist, making the assets more or less worthless and requiring firms to "write down" their value, causing losses to the firms that hold them.
Mr. Forbes suggests that the write-downs resulting from mark-to-market rules forced firms to raise new capital to satisfy the minimum levels regulators require financial institutions to hold. This caused "a death spiral" in which the need for new capital led to credit-rating reductions which in turn meant the need for more capital. So on and so forth.
Mr. Forbes then chides President Obama for maintaining this "worst" of former President Bush's "market mistakes":
Mark-to-market accounting is the principal reason why our financial system is in a meltdown...But bad ideas never die. Mark-to-market was resurrected by the Financial Accounting Standards Board and became effective in the fall of 2007 (FASB rule 157) to the approval of the Bush administration, its Treasury Department, and the Securities and Exchange Commission. Even as FASB 157 began to take its toll on financial institutions last year, Mr. Bush refused to kill or suspend it.
The gist: Accounting rules are causing the financial meltdown and President Obama has kept the accounting rules in place, so President Obama's accounting is causing the financial meltdown. Similar claims led Fed Chief Ben Bernanke yesterday to urge updates to mark-to-market rules, but pledge his continued support for the mark-to-market system.
Luckily - this is the first and only time I will write this - we have that behemoth of a bank bailout TARP. The legislation authorizing TARP also required the SEC to report on the role of mark-to-market accounting in the current financial crisis. The results show that Mr. Forbes is, at best, fudging his argument.
The SEC report concludes that
fair value accounting [mark-to-market accounting ] did not appear to play a meaningful role in bank failures occurring during 2008. Rather, bank failures in the U.S. appeared to be the result of growing probable credit losses, concerns about asset quality, and, in certain cases, eroding lender and investor confidence. For the failed banks that did recognize sizable fair value losses, it does not appear that the reporting of these losses was the reason the bank failed. (p.4)
Essentially, this means that firms' "paper losses" reflected - surprise, surprise - bad stuff going on in the real world. In fact, one of the causes of the recent terrible performance of GE's stock is that only 2% of its assets are valued at market prices using mark-to-market rules, while the other 98% is "opaque", leading to investor concern about the health of that 98%. As a JPMorgan analyst put it:
Blaming the rule "is a lot like going to a doctor for a diagnosis and then blaming him for telling you that you are sick"
But perhaps more damning is the report's revelation that that dastardly FASB rule 157 doesn't even require mark-to-market accounting. In fact, the rule only provides guidance for firms to use when measuring fair market value. While Mr. Forbes implies that Bush "resurrected" mark-to-market, the SEC report notes that 157 only increased the rule's usage. The percentage of assets valued at fair value in 2006 (before 157's adoption) was 42%, increasing to 45% in the first quarter of 2008 (see p.57); the increase in liabilities reported at fair value was more significant, rising from 8% to 15% (see p.72). FASB rule 157 might have increased mark-to-market's usage, but the rule was not a Bush administration innovation.
As the report concludes:
[suspension of FASB rule 157] would not itself change fair value accounting requirements, but rather remove the currently operative guidance for implementation. (p.6)
I'm not an accountant or a banker or a businessman. And I do, in fact, share Mr. Forbes's concern that mark-to-market might be depressing lending, as well, dare I say, it perhaps should.
But explaining away our current financial crisis with an accounting rule - an argument that Mr. Forbes has made before - and placing the onus on the current President to do away with it, is disingenuous. It not only whizzes by valid ideological questions - is something "worth" the price I could sell it for now, the price I bought it for, or the price it will be worth in the future - but quite clumsily implies that deregulation is again the answer to our financial woes.
Still, if Mr. Forbes insists, I only request equal treatment. My household balance sheet would look much better if my home weren't valued at the price it would currently fetch on the market.