September 26, 2008
Mark-to-Market Accounting Gets a Bad Rap
Mark-to-Market accounting is a rule of transparency -- companies have to discuss the fair value of assets on their balance sheet. One can criticize the mechanics of the rule on illiquid assets or in times of extreme market distress (when there is a lack of a market equilibrium price) but one should not attribute bank's capital problems to the rule. Bank's capital problems come from two other sources, both legal: 1) Statutory/administrative capital requirements and 2) contracts (most, commonly swap agreements). When a bank has to reduce asset values it can fail its legal or contractual capital requirements. The legal capital requirements are the real problem and need revision -they are too inflexible. The contractual capital covenants are the bank's own fault and can be defined however they want -they just were lazy and too content with simplistic language. Modify mark-to-market accounting rules only to accomplish fair value transparency; modify legal capital requirements to account for market distress; and leave firms to draft better capital requirement covenants in contracts.
September 26, 2008 | Permalink
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Tracked on Oct 4, 2008 1:18:24 AM
"The legal capital requirements are the real problem and need revision -they are too inflexible"
This has been unreported in this left-vs-right view of the issue. Banks were being castigated by accountants and the SEC for holding too much reserves against loans in 1998-2000, Suntrust being the biggest I remember. Well, the accountants and the SEC got what they wanted, pro-cyclical reserving. Indymac could only justify 31 bps of loan loss provisions in 2006. Why? CA realestate was very strong, losses were well below even that 31 bps level. Recession comes, bye-bye earnings, capital, and eventually solvency.
Basel II treated mortgage assets as the lowest risk assets after sovereign debt ... they'll rethink that going forward.
Posted by: g | Sep 28, 2008 12:09:54 AM
Posted by: miky | Nov 13, 2008 9:52:52 AM