Mark-to-Market: Prospects for Change

There is a lot of buzz about a Congressional hearing on mark-to-market accounting, scheduled for Thursday.  Much of the information is inaccurate or misleading.  Astute investors should understand the purpose of the hearing and what might happen.


When Congress passed the original TARP legislation it required the SEC to study the  possible link between accounting rules and bank failures, reporting within 90 days.  They complied with a series of round tables, public commentary and a report.  This was the last action of the Christopher Cox Chairmanship, with Cox and senior staffers leaving immediately thereafter.  The recommendation was to keep the rule and do minor tweaks.  This is not what Congress expected or hoped for.

The Obama Administration

We have watched closely for a sign of interest from the Obama team concerning this issue, but there has not been much.  Paul Volcker, a senior advisor, favors a change, but there is no sign from anyone else.

Few seem to understand the rules.  Tonight on Kudlow, Steve Forbes, a strong advocate for suspending the mark-to-market rules, stated that the President or the Treasury could change this with a stroke of the pen.  This is not correct.

The accounting rules, as we have frequently written here, are determined by the Financial Accounting Standards Board (FASB), a group that strongly embraces using market prices.  The oversight of FASB is completely under SEC control  The new SEC chair, Mary Schapiro, showed little interest in this subject during confirmation.

This is not something that Treasury can change or the President can change.  The President cannot even fire Schapiro.  He had his chance in making the initial appointment, and it apparently was not an issue on the front burner.

The Hearings

Thursday's hearings are in front of the House Financial Services Subcommittee on Capital Markets.  What does this really mean?

In the legislative process this does not mean much.  A sub-committee has hearings and perhaps reports a bill to the full committee.  There is then another vote.  The bill needs a "rule" from the House Rules Committee.  Perhaps it gets one and a vote on the House floor.  Then the process is repeated in the Senate.  If a bill is passed in both houses, it goes to a conference committee to reconcile differences.  The final version, if passed, goes to the President for his signature.

We are astounded at the lack of information about basic political processes from everyone covering this story.  It is all the material from an introductory class on American Government.

The Real Message of the Hearings

Most Congressional hearings are not really about passing new legislation, although that is always the stated purpose.  Sometimes it is just intended to send a message.  Readers who are sports fans might remember Congressional interest in the BCS and football playoffs, baseball and steroids, or similar topics.  Congress uses the power to conduct hearings to create a body of information and to focus attention.  By threatening legislation, they move others to change behavior.

In this week's hearings we expect testimony from accountants who will emphasize the significance of market-based pricing to ensure visibility for investors and to avoid future Enron's.  This will include official SEC accounting experts.

There will also be some who explain the pro-cyclical nature of the current accounting experiment, conducted in real time.

The issue cuts across partisan lines.  Many Republicans prefer relief on mark-to-market accounting to additional TARP-style investments.  The destruction of regulatory capital via the FAS 157 rule has proceeded far more rapidly than the government can or will provide new investments.  In addition, the system has discouraged any private investors.  Many free-market adherents would prefer some regulatory relief rather than a system where Barney Frank tells  private companies whether they can conduct golf tournaments.  It is a philosophical position.

Democrats are mixed in their viewpoints, which should make entertaining viewing for policy wonks.

Investment Insight

Anyone looking for an investment angle can ask two very simple questions:

  1. Are the most important Committee members trying to send a message to the SEC?
  2. Is Mary Schapiro listening?

Unless the answer to both questions is "yes", investors have a long wait for any relief on the FAS 157 rules.

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  • Russ Wood March 10, 2009  

    Thanks for pointing out Forbes’s error, which I have heard elsewhere and assumed to be correct.
    I wonder if you can address how SarBox factors in with MTM. Even if MTM is suspended or otherwise relaxed, my understanding is that SarBox would still criminalize erroneous financial statements. Is suspension of FAS 157 enough to allow banks to update their balance sheets, or will they remain restrained by SarBox.

  • John Sweda March 10, 2009  

    Good post. A bipartisan bill, HR 1349, has been introduced in the House:
    “Accounting standard setters would have their decisions vetted by a new five-member oversight board composed of financial regulators, under U.S. House legislation introduced Friday, March 6th.
    The bill, introduced by Reps. Ed Perlmutter, D-Colo., and Frank Lucas, R-Okla., would establish a new oversight board with authority to adjust generally accepted accounting principles, or GAAP, to consider such factors as the extent to which the standards create systemic risk to the U.S. public and to U.S. and global financial markets.
    The Federal Reserve chairman, the Treasury secretary, the SEC chairman, the Federal Deposit Insurance Corp. chairman and the Public Company Accounting Oversight Board chairman would sit on the new board.”
    Personally, I do not think this bill will ever make it out of committee. The majority of Congress would not want to be instrumental in creating a mechanism to oversee the current responsibilities of the SEC.

  • Trevor @ Financial Nut March 10, 2009  

    I guess we’ll just have to wait and see what happens. I just hope SOMETHING happens soon!
    By the way, I just found you via Wisebread’s Top 100 PF Blogs. Congrats on making the list!

  • Jeff Miller March 10, 2009  

    Russ- The modifications I have seen suggested do not affect SarBox. The top officials sign the balance sheets. FAS 157 changes might alter what counts as regulatory capital, but the holdings would still be reported in footnotes.
    It is possible to have transparency for investors without exacerbating the economic cycle.
    Thanks for a great question.

  • Jeff Miller March 10, 2009  

    John — As you can see, I agree. I think it is a warning shot over the bow — at least for the moment. In a year or so we will see a complete reform of the regulatory agencies, combining the SEC and the CFTC and covering credit default swaps.
    The hearings are a very early stage, and the reform process is much too slow for the current crisis. It is the next war.
    Thanks for your thoughtful comment.

  • Jeff Miller March 10, 2009  

    Trevor — Even those of us who can take short positions do better in a rising market. We are overdue for reform on this issue.

  • Lance Paddock March 26, 2009  

    I still have a huge problem with you claiming this is a large issue when the banks are not, and have not, been marking their assets to market anyway, as I pointed out earlier. There are a lot of reasons why, but the upshot is they are not.
    Whether mark to market exists or not in its current form seems rather a moot point given that fact.
    For example, Citi is carrying its mortgage and home equity lines at 94, construction and commercial mortgage loans at par, C&I at 96 and consumer loans at 86. None of those marks are anywhere close to reasonable. Therefore, as I pointed out before, the market may be undervaluing these assets by a huge margin (and given the money I am putting towards buying them at market rates I certainly hope many are very undervalued) but Citi is toast with any reasonable mark.
    Of course, that is mostly loans. The securitized instruments should have much lower marks, and do, but those are not reasonable either. The subordinate tranches are severely stressed, many are worthless. In the Alt A and subprime space even the senior tranches are suspect, and amongst the CDO’s, especially fully synthetic ones, the market is dead on with the low marks. Suspending MTM on those securities accomplishes nothing but delaying the losses on a very short term basis. Investors will see right through that.
    The real losses to come are in the loans and CMBS. Those are carried at ridiculous marks and suspending MTM will have no bearing.
    Lets put it another way. The collateral of the debt the banks are carrying has been marked down by 30-70% almost across the board (for total losses well in excess of 12 trillion.) Exactly how do loans, and securities derived from them, with collateral losses of that magnitude end up with anything less in terms of losses than we have seen, and are being predicted, whatever the accounting?

  • Jeff Miller March 29, 2009  

    Lance – I respect your opinion and appreciate your thoughtful comment. I am writing an article highlighting the four or five best pieces on this topic. These sources are in sharp contrast to your estimates.
    I want to defer further comment until we can both review these articles.
    We will all soon learn much more about the value of these assets, ending speculation.