The FASB’s recommendation is to fair value all assets on the balance sheet.

This is an incredibly bad idea. This will lead to an increase in asset repricing frequency, which leads to a short term holding mentality. Banks will hesitate to lend long-term if they know that shortly after they make a loan, they could be forced to mark the loan down to its “market value.”

Going hand in hand with this is that short-term market value write-downs – on long-term assets – will decrease capital at banks, which will in turn decrease their capacity to lend.

We want longer management of longer term assets. Let financial institutions carry assets at whatever level they fully disclose, and force them to footnote the “market value.” Full disclosure will provide investors with all of the information they need to make decisions. This improves disclosure and transparency without draining capital out of the banking system.

Comments on FASB Recommendation – www.FASB.org

Stop This Horror Before It Starts Again – Forbes Magazine, June 28, 2010

FASB Technical Plan and Project Updates – FASB.org, March 10, 2010

Additionally, one of the greatest investors of our time is stating that at their current market prices, some of these “toxic” assets – distressed mortgages – represent the best potential returns going forward because they are trading below fair value.  This is further evidence that the market, or liquidation value of many of these securities is well below their true economic value.

Conclusion: Mark-to-market accounting rules are forcing banks to write their securities down to values well below their economic value.

Watch Steve Forbes on CNBC below.

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.

We concur with Ed’s statement that the OTTI model used by international accounting standards is superior to the U.S. approach and consistent with all other financial assets.  While the Financial Accounting Standards Board (FASB) is in the process of reviewing mark-to-market rules, they should give this topic of OTTI full consideration. We’ll take it a step further by adding that U.S. GAAP and the International Accounting Standards Board (IASB) have already committed to “converging” their rules over time.

While we understand that this convergence is a step-by-step process and takes time, we believe that prioritizing and immediately modifying U.S. accounting rules on OTTI makes sense since convergence is already forthcoming at some point and this issue needs attention today. The international rules are superior to those of the United States given the punitive nature of the U.S. rules in distressed markets, and the organizations should focus on converging the largest, most pressing issues first.

For more information on OTTI, please watch our video below.

Watch Ed Yingling on CNBC below.