The Mark to Market Showdown

I am no expert on "mark to market" accounting rules, which means that this pretextual throat clearing is my introduction to an "expert" post about.... "mark to market" accounting rules. My actual interest is the intersection of what government wants to do and what the market is willing to bear. The Treasury's toxic asset / "legacy asset" program, PPIP, is predicated on the reasonable assumption that banks want liposuction to remove ungainly bulges of hardened mortgage fat, and the government has found a way to pay for it.

Yesterday, the Federal Accounting Standards Board voted to relax mark-to-market rules for mortgage-backed securities. The banks liked this move, because it allows them to hold off on writing down some of their assets and provides the near-term illusion of more liquidity. I asked a Treasury official if this wouldn't reduce incentives for bigger banks to participate in PPIP. It shouldn't, the official replied, "because the actual value of the asset is not changing. It allows them to change their accounting practices, but the market value of the asset doesn't change."

That's definitely true from the standpoint of the buyers. They don't care what value the banks put on these assets. They care about the intrinsic value.  But the uncertainty creeps to the seller's point of view. A big part of their sale decision will relate to what their own internal view is of an asset's intrinsic value regardless of accounting treatment too.

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"That illusion is not going to fool the people they'd like to raise private capital from, and they can only raise that private capital if they've cleaned up their balance sheets of these
assets," the Treasury official told me.

The government reasons as follows: when the market is in the crapper, short-term values -- market values -- are lower than long-term values -- intrinsic values.  So -- why you would have to take losses when you're not planning on selling? And if you're not planning on selling, then you aren't planning on participating in PPIP anyway. QED.

Another noodle-bender here is that if PPIP is successful, then the market values will become clearer, and, even with the changes, the securities in question won't meet the standards for "illiquid."  So, in both cases, there are going to be two sets of books and two values on the same asset. And only one of them will matter.

An investment banker I know put it this way:

    I think the whole issue gets tricky because the concept of "marking to market" actually depends on their being a market.  As liquidity decreases to zero, the whole notion of having a market to mark to is called into question.  The rules already contemplate this problem and created a set of assets (Level 3 assets) which are technically "mark to market" but which are determined by internal analysis as opposed to external prices.  This has been mocked as "mark to make believe."  But one could argue that forcing people to mark to market for some of these securities is an external mark to make believe as invalid as an internal mark to make believe.

So  -- one can argue that there is some tension between FASB and PIPP. But both are designed to stabilize bank balance sheets and earnings by pushing up asset values (either through cash purchase or accounting policy) and thereby (in theory) relieve the banks of some pressure on their equity.

PIPP is doing it by setting new, more transparent prices and removing assets from the banks at the cost of exposing taxpayers to losses.

FASB, my I-banker friend interprets for me, is doing it by making it possible for banks to avoid writedowns and improve capital levels but at the expense of some transparency on balance sheets.

Despite all the huffing and puffing on both sides, there isn't really a "right" answer for an accounting purist.  The point being, accounting for these securities doesn't come from God or Roger Penrose.  It's a discretionary call about what the best way to think about a firm given it's current position and it's way of thinking about its business in the future.  That's the heart of accounting and why it can be so controversial.