Policymakers Ease Mark-to-Market Rules

Last week, the ""Financial Accounting Standards Board"":http://www.fasb.org (FASB) approved new, relaxed guidelines for ""mark-to-market"" accounting rules - a method of assigning values to financial instruments, such as mortgage-backed securities, based on the current fair market price for similar instruments. The practice has faced stiff opposition from the mortgage industry as the housing contraction and rising foreclosures have sent real estate values plummeting.
Lenders argue that marking the value of securities to market, when the markets are as weak as they are now, has severely impaired liquidity for both commercial and residential mortgages, without accurately reflecting the real worth of these securities. The new guidance adopted by the FASB is expected to provide greater flexibility to address this problem.
Under the ""new guidelines"":http://www.fasb.org/action/sbd040209.shtml, financial institutions will be allowed to use internal models that employ conditions of a steady market rather than current values reflecting a market that is disorderly and inactive as a result of excessive swings in the financial system and the deeply receded economy. The FASB's decision will also allow them to take into account the cash flow of securities when determining their worth.
Robert Willens, a former managing director at Lehman Brothers Holdings Inc., told _""Bloomberg News"":http://www.bloomberg.com_ that the change could boost bank industry earnings by as much as 20 percent.
Many analysts and economists have placed much of the blame for the subprime mortgage crisis on the Securities and Exchange Commission (SEC) and its fair-value accounting rules, in particular the requirement that banks mark-to-market the values of their mortgage assets and mortgage-backed securities (MBS). The intent of the standard when it was first instituted was to help investors better understand the value of these assets at a particular point in time, rather than just their historical purchase price.
But since the market for these mortgage assets is now so distressed, it has become difficult to sell MBS except at prices that reflect current market tensions and are typically well below the value of the cash flow related to the MBS. As a result, many large financial institutions have recorded significant losses since the housing downturn, largely attributed to marking down MBS asset prices to current depressed values.
According to Brian Wesbury and Robert Stein of First Trust Portfolios, the last time mark-to-market accounting was in effect - during the Great Depression - it caused many bank failures.
In a recent article for _""Forbes"":http://www.forbes.com_ magazine, Wesbury and Stein wrote, ""The history seems clear. Mark-to-market accounting existed in the Great Depression, and according to Milton Friedman, who wrote about it just 30 years after the fact, it was responsible for the failure of many banks. Franklin Roosevelt suspended it in 1938, and between then and 2007 there were no panics or depressions. But when [the rule] went [back] into effect in 2007, reintroducing mark-to-market accounting, look what happened.""
Members of Congress and industry representatives, including financial institutions, securities investors, and auditors, have stepped up their requests of late for clarification of the fair value accounting guidelines and the mark-to-market accounting application in light of diminishing market liquidity.
FASB's changes last week to these controversial accounting rules come just in time for financial institutions' first quarter financial statements and the bank stress tests planned by the administration to determine if companies possess enough capital to weather the nation's economic storm.
However, according to a _""Wall Street Journal"":http://www.wsjonline.com_ report, now that the dust has settled from the mark-to-market adjustments, the consensus of analysts and accountants is that the effect on bank earnings will be ""minimal.""
According to the _Journal_, several large banks have hinted that, at least for now, they will not change how they mark, up or down, the securities they are holding. Citigroup Inc. told the paper that FASB's decision on giving bankers more leeway in fair value accounting ""will have no impact on Citigroup's financial statements or our existing practices for determining fair values.""