Limited Government Leads to Economic Growth
Mr. George Melloan retired in 2006 after a 54-year writing and editing career at The Wall Street Journal, where he was a key member of the Journal’s editorial-page staff during the 1970s. He has also written the book, The Great Money Binge, in which he makes the case that less regulation is needed to promote economic growth.
In The Great Money Binge, Mr. Melloan blames mark-to-market accounting rules required by the Financial Accounting Standards Board in 2007 for adding gasoline to the fire of the financial crisis.
Mr. Melloan says that requiring companies to adjust their books every time an asset changed value resulted in showing paper losses that had a cascading effect. Companies were forced to sell assets that they had intended to hold and thereby lowered prices further.
“Since uncertainty had locked up the market for [mortgage-backed securities], the mark-to-market rule exacerbated the problem. How do you mark something to market if there is no market?”
The Great Money Binge is published by Threshold Editions.
Make No Little Plans
The President’s Economic Recovery Advisory Board, headed by the venerable Paul Volcker who has seen his share of economic woes, is pushing to double exports as a percentage of GDP.
And we’d all like to be thinner, younger, and richer.
That’s not to say it can’t be done, but given that our policies over the last 30 years have all but outsourced our manufacturing sector and of hundreds of industries, about all that we have left to export are agricultural products and bulldozers.
The US was once the world’s leading manufacturer of near everything but chopsticks. We have traded that to be the world’s biggest shopping mall.
With that said, the goal is ambitious. To rebuild America’s manufacturing infrastructure implementing 21st century technology to effectively compete with clumsy labor-intensive manufacturing from the third world is exciting. This may be more than the Economic Recovery Advisory Board had in mind, but Americans have never been known for thinking small. As the oft-quoted architect Daniel Burnham once encouraged, “Make no little plans; they have no magic to stir men’s blood…Make big plans, aim high in hope and work.”
Why Go Back?
There were mark-to-market rules during the Great Depression. Franklin Roosevelt had the good sense to suspend them in 1938. For the next 70 years? No problems. Then in 2007 the Federal Accounting Standards Board (FASB), went back to those halcyon days of 1936 and brought back mark-to-market accounting and forced banks to take losses before they happen.
You can burn a lot of calories wondering why the FASB didn’t leave well enough alone.
After a virtual banking collapse, in April of this year the FASB re-suspended the rules. And surprise, banks are suddenly in better shape. What’s more, it didn’t cost any one a dime, taxpayers have probably saved billions in bailout funds, and there is widespread optimism that the economy is turning around.
And oh yeah. The investments the FASB wanted downgraded by mark-to-market? Using the same mark-to-market rules, they’re worth more, too.
So why does the FASB now want to go back yet again to an archaic rule that exacerbated the Great Depression and clearly made the Great Recession far worse than necessary?
We can only speculate. But it’s clear that more than a few FASB members are miffed that they look like they caved to political pressure. I agree that having Barney Frank and Paul Kanjorski in your kitchen isn’t fun, but do you really want to see banks and the economy crumble again?
FASB Update
While there are some in the media that are suggesting this is a sudden reversal of the decisions made last April, it is actually part of a process that started years ago. Both the FASB and the International Accounting Standards Board (IASB) have a long term stated objective that the primary accounting for ALL financial instruments including liabilities should be fair value. They are now in the first steps of a very long process on how to exactly do this.
The initial recommendation is that fair value be the default accounting for financial instruments on the balance sheet. However, other factors such as the institution’s business model (buy and hold versus trade, for example) and characteristics of the financial instrument (cash flow volatility, derivative, market activity), along with other factors will determine whether the unrealized gain or loss is recorded in the income statement or the balance sheet via other comprehensive income. These determining factors have not been laid out in detail yet as they are at the conceptual stage. It very well may be that they are the same concepts used now for securities (primarily based on intent) with a few twists. What is happening now is the first step in a long process on the best way to do this, which includes seeking comments from the industry. The ABA came out quickly with a letter to the FASB with their opinions.
This is an important issue that we will follow closely and may ultimately result in significant changes to accounting for financial instruments. It will also probably force regulatory changes to capital requirements and calculations. However, it is not a sudden reversal of the April decision that changed how fair value is determined in inactive markets or how it is used for impaired securities. It simply is the first step in implementing a long stated common objective of the FASB and IASB.
As fair values become more part of the accounting process for less active financial instruments, it will put more of the spotlight on pricing models that value credit such as loans. I’m very curious to see if the loan fair value models used by many big banks that resulted in fair values of their entire loan portfolios (including commercial, construction, land development loans and consumer) in the high 90s for the last several quarters receive a little more attention.
SEC’s Schapiro Said to Weigh Kroeker, Ciesielski as Accountant
July 30 (Bloomberg) — U.S. Securities and Exchange Commission Chairman Mary Schapiro has two finalists to be chief accountant: acting director James Kroeker and Baltimore money manager Jack Ciesielski, people familiar with the matter said.
Read the full article at Bloomberg.com
What’s going on with MTM these days?
As the great mark-to-market debate winds down, it appears that pragmatism has overcome rule keeping zeal.
The strict reading of the rules has been deemed as too pro-cyclical, and the FASB bent to the Congressional timetable. It is a decision that was fair, consistent, on time and appropriate. It was also a decision in which neither side was completely satisfied with the outcome, which in many cases can be the sign of a good compromise.
Opponents of M2M demanded the use of a market price for non traded securities, claiming that it extinguished nuanced examination and removed the possibility of biased estimates. But in the end the FASB clarified the rules, recognizing that this “liquidation based” price method for illiquid assets contravenes accounting conventions that have traditionally been applied to other types of assets, such as plant and equipment.
This exact and inflexible application of the rule reminds me of the famous military logic of “Burning down the village to save it.”
Accounting should reflect economic activity, not drive it.
The latent complaints will ring in into the empty forum, but the debate is over.
Some bonds are worth what someone will pay for them. Liquid securities
Some bonds are worth what their economic value is. Illiquid securities
For illiquid bonds, the mark to market has two components.
An institution has to mark down immediately the loss on the security that is real, or caused by credit losses, directly to earnings and Tier 1 capital .
The part of the devaluation, or “loss” in a security that is caused by a lack of liquidity, is charged to “Other Comprehensive Income”.
This final ruling by the FASB is not a get out of jail free card. The loss components are explicit, stated and accounted for.
There can be no complaint mounted on a lack of transparency argument.
We will resume the debate once we have a few field examinations, and we find out how the clarified FASB instructions are being applied. We might end up back here, the debate back on.
Until then, we will continue to publish news and other regulatory updates.
Kudlow & McTeer on MTM
See the attached video to hear year yet another prominent figure calling for changes to mark-to-market rules. Former Dallas Fed President Bob McTeer talks to Larry Kudlow about why accounting policy makers don’t want to change the rules.
