March 6, 2009
Mark-to-Market Accounting (and other Arcania)
Steve Forbes was on Fox's 'America's Newsroom' with Megyn Kelly this morning advocating the repeal of the "mark-to-market" accounting rule. He said it was rescinded in 1938 by FDR and led to economic recovery at the time - doing so now to reverse the Bush administration's return to it would have a similar benefit, he claimed.
I'm sympathetic to this cause based only on what I've learned from watching news stories over the last many months, so Forbes' plea to "call your congressman" because the president can change the rule by executive order got me back on the 'net to learn more.
According to Wikipedia, "Mark-to-market" was instituted by FASB's FAS 157 effective for fiscal years starting after November 15, 2007. It required assets to be valued on balance sheets for what they could be sold for, not their maturity value. [This is my non-financial professional interpretation of a bunch of technical jargon.]
In last year's TARP bill responding to the banking crisis was the authority (section 132) to suspend mark-to-market. Section 133 also directed SEC, Federal Reserve and Treasury to conduct a study on the policy and report back to congress within 90 days. SEC issued a report on December 10, 2008 concluding that mark-to-market would remain.
In the interim FASB issued new guidance that attempted to show how mark-to-market should be applied to determine the fair value of an asset "when the market for that financial asset is not active." Essentially, although the valuation should be made based on market value at the time it should reflect "the price that would be received by the holder of the financial asset in an orderly transaction (an exit price notion) that is not a forced liquidation or distressed sale at the measurement date."
Even in times of market dislocation, it is not appropriate to conclude that all market activity represents forced liquidations or distressed sales. However, it is also not appropriate to automatically conclude that any transaction price is determinative of fair value. Determining fair value in a dislocated market depends on the facts and circumstances and may require the use of significant judgment about whether individual transactions are forced liquidations or distressed sales.
To my untrained eye there appears to be much hocum, wet-finger gauging and other assorted subjectivities inherent in the rule. By way of example:
In determining fair value for a financial asset, the use of a reporting entity’s own assumptions about future cash flows and appropriately risk-adjusted discount rates is acceptable when relevant observable inputs are not available.
and
Broker (or pricing service) quotes may be an appropriate input when measuring fair value, but they are not necessarily determinative if an active market does not exist for the financial asset.
So the question is, "Is this any way to run a transparent free-market?" Seems more like job security for accountants and auditors to me. What was so bad about mark-to-value in the first place that we had to employ this inanity? There's some intelligent-looking discussion of it here.
Help us Perry! You're our only hope!
UPDATE: Hate to but in another's post, but Forbes has a guest editorial in the WSJ today which collects a lot of this.
Economics and Markets
Posted by JohnGalt at March 6, 2009 11:06 AM
Search your feelings, young padawan. You know what I say to be true.
The dark side surrounds us. Ever-vigilant we must be, if we are to overcome.
"He said it was rescinded in 1938 by FDR and led to economic recovery at the time"
This is nonsense. Forbes can't even get his facts straight, unless he's talking about the "recovery" that was (a) only statistical and (b) was as good as a physical therapist helping someone to walk again after the therapist hit him with a car. Real recovery didn't occur for nearly another full decade, and not just because one accounting rule was repealed. We don't need the government to stop making rules for businesses: we need to STOP the government from making rules for businesses.
However, repealing it is a start, though don't hold your breath. Those of you familiar with me and my writings know that I've called this a crisis perfectly engineered by government. Purposely caused and well-planned. The institution of mark-to-market was timed to make everything blow up at once, so we won't see it reversed until the damage is truly catastrophic.
I wrote last September:
I'm not an accountant, but I take a simple Austrian view: let buyers and sellers agree on whichever method works best for them. I personally view the clash over accounting methods as a red herring. It's coming down again to government setting rules that could very well be wrong. Both have strengths and weaknesses.
Mark-to-market realizes that we may not know something's true future value, so at the time we can only value it based on a current market price. Mutual funds' NAV, and margin account values, necessarily go by MTM. Part of my job is approving employees' personal investments based on being low enough that they won't negatively impact our clients' trades, and when they're trading options or futures, we go by what's effectively MTM. The problem is when you bought something for $1 million, and if it declines in value, mark-to-market means your books will show a loss. But in fact, you won't experience a loss unless you're actually trying to sell the whatever at that moment. If I buy a $500K house that in a year is worth less, even if it's down to zero, that doesn't necessarily mean I'll go bankrupt.
Now when you're dealing with something illiquid and/or uncertain in value, mark-to-model is useful. But even so, it inherently leaves people free to value changing/uncertain prices pretty much at whatever they want. Warren Buffett's been to correct to call it "mark-to-myth," although not to the extent he'd like us to think. But a lot of investing companies have used it to hide losses in their investments, and if they had had to report things based on mark-to-market.
In the end, we need not complicate things with accounting methods. We need only to let buyers and sellers be free to agree on a price, and for each side to accept the consequences of the decision without using government to coerce others into bailing out one or both sides. Putting this into an example, if you're going by mark-to-model in what you're offering to sell me, but I insist on mark-to-market, we of course won't agree. But it's not the accounting method that's important, it's the *price*. Value is subjective, however you calculated it.
Do you see how well this works? If you sell me a widget that the market says is worth $1, but I think it will be worth $10, I might offer you $2. You can value it at $2 or $3 on your ledgers, and call it "mark-to-model" or whatever you want. All it matters is that I can buy it, and you can sell it to me, at a price we agree on.
If I run a bank, and certain assets are worth zero on the current market, taking my bottom line negative, but I have a billion in cash, why shouldn't I be able to make loans? Our financial officers need only record the assets properly in our books, with two sets of values. If there's fraud, e.g. a willful misrepresentation of material facts, there were plenty of laws prior to SarbOx that punish such wrongdoing.
If a bank's owners don't like what management is doing, if they feel that money is being lent out imprudently when the assets are unlikely to recover, then they can fire the management. There is always some way for the free market to hold people accountable, without the government having to step in with its absurd rules.
Search your feelings, young padawan. You know what I say to be true.
The dark side surrounds us. Ever-vigilant we must be, if we are to overcome.
"He said it was rescinded in 1938 by FDR and led to economic recovery at the time"
This is nonsense. Forbes can't even get his facts straight, unless he's talking about the "recovery" that was (a) only statistical and (b) was as good as a physical therapist helping someone to walk again after the therapist hit him with a car. Real recovery didn't occur for nearly another full decade, and not just because one accounting rule was repealed. We don't need the government to stop making rules for businesses: we need to STOP the government from making rules for businesses.
However, repealing it is a start, though don't hold your breath. Those of you familiar with me and my writings know that I've called this a crisis perfectly engineered by government. Purposely caused and well-planned. The institution of mark-to-market was timed to make everything blow up at once, so we won't see it reversed until the damage is truly catastrophic.
I wrote last September:
Do you see how well this works? If you sell me a widget that the market says is worth $1, but I think it will be worth $10, I might offer you $2. You can value it at $2 or $3 on your ledgers, and call it "mark-to-model" or whatever you want. All it matters is that I can buy it, and you can sell it to me, at a price we agree on.If I run a bank, and certain assets are worth zero on the current market, taking my bottom line negative, but I have a billion in cash, why shouldn't I be able to make loans? Our financial officers need only record the assets properly in our books, with two sets of values. If there's fraud, e.g. a willful misrepresentation of material facts, there were plenty of laws prior to SarbOx that punish such wrongdoing.
If a bank's owners don't like what management is doing, if they feel that money is being lent out imprudently when the assets are unlikely to recover, then they can fire the management. There is always some way for the free market to hold people accountable, without the government having to step in with its absurd rules.
Posted by: Perry Eidelbus at March 6, 2009 1:20 PMThe answer is no, as in no way to run a free market.
However, once you have let the gub'mint in (insuring deposits, enforcing leverage ratios, &c.), you are stuck with their regulatory arm. Unlike the stimulus, it is not some evil scheme foisted on us to kill capitalism. If the government is responsible for margin requirements and leverage ratios, they make the rules about how assets are valued.
Put me down with Forbes for rescinding it, however, just another unintended consequence of government intrusion. Once the feeding frenzy begins, mark-to-market certainly amplifies it.
Posted by: jk at March 6, 2009 2:33 PMCase in point: Enron. While I completely agree with Perry's sentiments, it does no good for investors who "lost their entire life savings" to see the fraudsters frog-marched off to jail. Even if the punishment DID fit the crime (which it doesn't) those people have still "lost everything."
Qwest's Joe Naccio just lost his legal appeal for insider trading which netted him (and his wife) many millions of dollars so what's his punishment? 6 years in a country club prison. How many of us wouldn't take that deal if it weren't illegal? (Hell, I spent that long in a bad marriage!)
All told the solution appears to be, make the punishment for fraud more severe (longer terms in dirtier jails) and DIVERSIFY YOUR GORAM PORTFOLIO!!
Posted by: johngalt at March 7, 2009 11:49 AM | What do you think? [3]