All big guys are talking about mark-to-market accounting for the past few days. The House Financial Services subcommittee on capital markets is holding a hearing on this issue today, scheduled to begin at 10 a.m. EST, to explore problems facing mark-to-market accounting.
What is this mark-to-market accounting?
Basically the assets are marked to the market value. Mark-to-market accounting means that companies must value the assets on their balance sheets based on the latest market value of the assets even if the assets are not sold for that market value. This is the major problem for all banks because of declining mortgage value all across the country.
Let me explain. Assume that a bank made a $200 million loan on a building in San Francisco Downtown. Also, assume that buildings on both sides of this building were sold at foreclosure for $1 million each. This will bring down the market value of the building that took the loan from the bank. The building in this example is not sold. Still, the loan on this building has to be written down to market value of the defaults in the area. This is basically putting additional pressure on the banks that have billions in mortgages and loans. This also creates downward death spiral for many banks.
When there are more foreclosures in the area, the market value of the building goes down further. When the value of mortgage related securities goes down, the bank’s capital values go down. Then, the bank will struggle to maintain the capital required by regulation. Now, they will try to sell some assets to meet the capital requirement. This will further depress the market prices in the area. When all these happens, stock investors will get panicked and start to sell the stock of the bank. One more punch, the bank is dead or it will ask for bailout.
Few days ago, Warren Buffett called for suspension of mark-to-market accounting. He is the big investor in Wells Fargo. Naturally he is worried. Fed Chairman Ben Bernanke also commented that banks should not be forced to fail by arbitrary accounting rules. He supports mark-to-market but said the current rule may require adjustments to get past the current market meltdown. This was seen as a strong positive for the banks if a modified rule allows them to avoid further markdowns because of an illiquid market.
Rep. Paul Kanjorski, D-Pa., the panel’s chairman, doesn’t agree for the suspension of mark-to-market. “While companies need stability, investors still need accurate information,” he said in a statement. “We therefore cannot allow for fantasy accounting that wishes away bad assets by merely concealing them. I want to find a way to still provide investors with the information needed to make effective decisions without continuing to impose undue burdens on financial institutions”.
Let us hope that something good comes out of today’s hearing. Any good news for the banks will trigger another stock market rally. Whether that rally can be sustained is a totally different question!
Related Link: House panel looks at accounting rules
