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Nixing 'Mark to Market' Won't Solve the Problem

Why nix mark to markeyt? This is what I wrote yesterday in Oz...
It's amazing the positives that can flow from a little market adversity.
Following a particularly savage kicking from Wall Street, a chastened Congress appears to have "discovered" the logic of the US Treasury's Troubled Assets Relief Program.
At the same time, in a move that could considerably boost TARP's effectiveness, the Financial Accounting Standards Board (FASB) and the US Securities and Exchange Commission have embarked on a timely "interpretive" review of the much-maligned "fair value accounting" rule.
This move to capture more of the spirit, rather than simply the letter, of the law opens the door to a more expansive representation of banking sector balance sheets.
Fair value, or mark-to-market, accounting has proved a major killer for global credit markets over the life of the sub-prime crisis. This approach to asset valuation calls for companies to assess a disposal price of financial assets "at the measurement date" and not the potential value of the asset at some future date.
This may have been logical in a stable market, but when asset values are in retreat and a majority of holders become potential sellers, then the "at the measurement date" requirement has forced accountants to gravitate towards what in essence are fire sale valuations. This is particularly so when the assets in question are over-the-counter obligations that do not trade in a liquid marketplace, such as issuer-sponsored residential mortgage-backed securities, or the collateralised debt obligations that they spawned.
The result has been a seemingly self-fulfilling spiral lower in the asset values underpinning financial market balance sheets. Write-downs have at best led to significant contraction in the supply of credit. At worst they've precipitated full-scale corporate collapse.
Over recent weeks I've discussed the "duration" logic behind TARP - its capacity in the short term to soak up distressed assets from banks with a view to retaining them, long term, for "orderly realisation".
This in effect points to a Treasury arbitrage of FASB's fair value rule, as it would see assets acquired approaching fire sale book value then disposed of at valuations that would apply in an orderly market.
This distinction highlights why any change to mark-to-market accounting is so important. Whether through its scrapping or through a less draconian interpretation, the banking sector would immediately face the prospect of a round of positive financial asset revaluations.
Balance sheets would be boosted. System lending capacity would be lifted. Ultimately, the unfolding credit squeeze would be eased.
Given these are the very goals that TARP is aimed at achieving, were it to be implemented in conjunction with a change to fair value accounting rules, its task would overnight become a whole lot easier. In effect, $US700 billion ($840 billion) of acquisition capacity would deliver far greater bang for the buck.
Even if it meant relying upon a more flexible interpretation, rather than a wholesale rescinding, of FASB fair value accounting statement 157, this sounds like a logical win for legislators.
On Tuesday FASB issued "clarifications" aimed at delivering a looser application of existing rules. In particular, it encouraged companies to rely on their own judgements in determining asset values, including "expectations of future cash flows" from an asset, so long as appropriate risk premium had been applied.
This opened the door to "present value" assessments, which could prove radically higher than "at the measurement date" valuations.
The FASB statement also suggested alternative means of looking beyond the "temporary impairment pricing" that results from "disorderly" market disposals.
Given impaired value write-downs have been a key feature of many of the substantial losses that have been booked by investment banks over recent months, this could prove a major concession.