Accounting rule changed

The SEC changed the mark to market rule, a simple revision that could do a lot to ease the credit crisis. Power Line explains:

As the economic crisis has deepened over the last several weeks, a number of knowledgeable people have told me that the simplest thing the government could do that would have a significant effect on the availability of credit is to ease the “mark to market” rule. A couple of hours ago, the SEC did just that. . . .

The mark to market accounting rule has been a significant cause of the drying up of credit. Currently, there is no market for a broad range of financial instruments that are backed by mortgage portfolios. Under the old version of the rule, banks had to value such assets at zero. That’s not right; most of them ultimately will have value. But currently, given the uncertainties surrounding the subprime market and some of the instruments themselves, no one wants to buy them.

The effect of such asset write-downs is that the amount of money the bank is allowed to lend is reduced. Thus, the SEC’s clarification to the rule should have the effect, in the immediate future, of freeing up a considerable amount of credit.

About Gene Veith

Professor of Literature at Patrick Henry College, the Director of the Cranach Institute at Concordia Theological Seminary, a columnist for World Magazine and TableTalk, and the author of 18 books on different facets of Christianity & Culture.

  • TK

    Word in the industry over a week ago was that “mark to market” had a lot to do with the paper losses forcing investment firms companies bankrupt (I made a long comment about that here). A return to the practice (which had been eliminated by FASB 157 and deemed a corrupt practice) can really only be a temporary fix…kinda like turning the clock back. Weird.

  • Ethan

    Barry Ritholtz links to an article here.

    “If FASB 157 is suspended, I would advise our clients and the investing public that owning any financials that failed to disclose their holdings accurately were no longer investments — they were pure speculations, with more in common to spinning a roulette wheel than owning Berkshire Hathaway (BRK) or Apple (AAPL) or Google (GOOG). Indeed, I know of no faster way to end up on the DO NOT OWN list than to hide from your shareholders what is on your books.

    If investors cannot trust the valuations of what is on a firms books, they simply cannot invest in these firms PERIOD. “

  • Joe

    I find that very interesting considering that FASB 157 did not come into existence until December of 2007. Prior to that time banks were free to use methods of evaluation other than mark-to-market. So was this guy keeping all investment banks on his DO NOT OWN list from the beginning of time until December of 2007?

  • eric

    This is a major change.

    I think this quote means that the value does not stay fixed at the purchase price, but the value has to be adjusted to the income stream instead.

    “[w]hen an active market for a security does not exist, the use of management estimates that incorporate current market participant expectations of future cash flows, and include appropriate risk premiums, is acceptable.”

    So basicly a company has to use some kind of income valuation for an asset that has no market price. But can a “future” income stream, that is not a WAG, be determined for these complicated, sliced and diced mortgage securities?

  • Joe

    eric – they can. In fact, Kudlow did it in some of pro-bail cause well all get rich off them. It was the mark-to-market valuation that became impossible due to a lack of market. There are other methods to predict value in a fairly lucid manner.

  • Joe

    Of course, typing lucidly is way harder …

  • FW

    the posted article does not give enough information.

    what is the “basis” for valuation is what I would like to know.

    as my accounting professor said, “income is a matter of opinion, cash is real”.

    sounds like the us government is gonna allow firms to “cook the books” to create asset value that is not real.

    anybody have anything more about this?

  • Joe

    Frank – I have made the assumption (dangerous I know) that since they are repealing a rule that went into effect just this year (well December of 2007) that former standards would be back in effect. Some of that will depend on wording, etc. But it seems like the logical result (but since this is the gov’t we dealing with it probably won’t work that way).