In Defense of Mark to Market

by: Belvedere

After weeks of handing over the microphone to anyone who wants to bash mark-to-market accounting on its op-ed page, the Wall Street Journal decides a little equal time is in order. They handed over the mike to Mr. James Chanos, who provided an excellent analysis of the problems facing investors and the FASB at this pivotal moment in its history. From the editorial:

"The FASB and Securities and Exchange Commission (SEC) must stand firm in their respective efforts to ensure that investors get a true sense of the losses facing banks and investment firms. To be sure, we should work to make MTM accounting more precise, following, for example, the counsel of the President's Working Group on Financial Markets and the SEC's December 2008 recommendations for achieving greater clarity in valuation approaches.

Unfortunately, the FASB proposal on March 16 represents capitulation. It calls for "significant judgment" by banks in determining if a market or an asset is "inactive" and if a transaction is "distressed." This would give banks more discretion to throw out "quotes" and use valuation alternatives, including cash-flow estimates, to determine value in illiquid markets. In other words, it allows banks to substitute their own wishful-thinking judgments of value for market prices."

He's hit the nail on the head, I believe. While FASB is being yoked by Congress to "do something about mark-to-market accounting" before legislators do, they don't have to do harm. They could "do something" by sharpening disclosures for investors, for one thing.

The stability of financial institutions' capital can be extremely dependent on the very same securities they'll now have much more leeway in valuing.

Given that these proposals will affect regulatory capital, I don't think that diddling with the figures investors use is the right way for regulators to handle their responsibility for setting capital limits. Chanos is dead right in his suggestion that regulators "temporarily relax the arbitrary levels of regulatory capital, rather than compromise the integrity of all financial statements."