Friday, March 6, 2009

More On Mark To Market

Opponents of the repeal or modification of FASB 157 (mark-to-market accounting) scoff at the idea, using neat and debate-stopping phrases as "mark-to-fantasy." It's just not that simple. There is a big difference between the intrinsic value of a security and the market value of the security. Mark-to-market essentially ignores the intrinsic value, even if the institution never plans to sell the asset.

If an asset is truly impaired, the institution in EVERY case is forced to mark the asset down. In the case of a loan or security which is seriously delinquent on intererest and principal, a write down will occur, with or without FASB 157.

But what if an institution holds a security that is current on both interest and principal, and they plan to hold the security to maturity? Because there are few buyers out there for such a security, should the institution be forced to write down the value of the asset, affecting its regulatory capital ratios and the now-all-important tangible common equity ratio? Abetted by new ways to short the stock without having to borrow (i.e., levered ETFs and the simple lack of enforcement of Reg SHO), this is a short-seller's dream! The end result is systemic risk for the financial system and the world economy. (Steve Forbes has an excellent op-ed piece in today's Wall Street Journal.)

The real debate, I believe, is whether or not the market for these securities (or lack of a market) is truly prescient regarding the asset's future value. In other words, perhaps the market is correctly assessing a future rise in default rates. Unfortunately, this might become a self-fulfilling, however unnecessary, prophecy.

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