Problems with MTM
Heads up . . . this is an excellent article from the Viewpoint section of American Banker, [$$] Repeal Mark-to-Market to End Crisis. George Sutton does a great job of articulating some of the main problems with using mark-to-market accounting for banks . . . who are LONG-TERM investors. He says . . .
I was a regulator in the 1980s, during the savings and loan crisis when all kinds of depository institutions failed in numbers second only to the Great Depression’s toll.
During this time I heard one Federal Deposit Insurance Corp. official say they generally lost about 20% of asset value when liquidating a bank. Some people wondered whether, by that measure, banks should be required to hold 20% more capital to cover potential liquidation losses. If so, there would be virtually no solvent banks. Of course, that is not an appropriate standard because it presumes every institution would be liquidated – and value is lost in liquidation that is preserved in a going concern.
Yet that in a nutshell describes mark-to-market accounting, which the Financial Accounting Standards Board, or FASB, decreed as the accounting standard for all U.S. financial institutions, beginning in 2007. This rule says assets held by a bank or other type of lender have no value other than what they can be sold for each day – an appropriate measure for common stock but flat-out wrong for income-producing assets such as loans and interests in loan pools.
A bank has options when markets become dysfunctional, as they are now. Lenders do not have to sell loans. They can always hold their receivables and live off the payments. The payment streams have real value well above their sale value in the current market. The mark-to-market standard assumes that the value of the payment streams is inherent in the sale price. What this does not take into account is market disruptions during which buyers will not pay full value for a loan.
As a result, mark to market undervalues income-producing assets during a market downturn and severely undervalues them during a severe disruption like today’s.
