More Thoughts On M2M Effects

It's not just about banks. As FASB considers the various proposed modifications to FAS 157, some are placing the emphasis on the wrong issues. This is not just about financial companies, although the first impact is there. It may correct a situation where we have been "removing" regulatory capital from banks at warp speed. It was a process that government action could not offset, and which discouraged any fresh private capital. It meant that a bank could be defined as "insolvent" even when assets were performing.

The problems have been documented for many months -- CPA's have written that the rule was OK, but the implementation was incorrect. If there had been more experience, accountants would have used the flexibility provided. Perhaps, but accountants are very conservative in implementing rules -- especially in the post Arthur Andersen era. Today's actions will provide more explicit rules for determining when a security is illiquid.

This is not just today's issue, since it will have an effect on the return to normal and sensible lending through the impact on regulatory capital. All of the information about assets will still be in the corporate reports.

Since I value transparency as much as the next guy, I do support mark to market in a relatively pure form. As Warren Buffett has pointed out, the alternatives to mark to market are mark to model and mark to myth. The results are so-called Level 2 and Level 3 assets. We don't need any more of them. Just about any institution with a balance sheet predominantly made up of the latter assets is basically insolvent anyway.

But detractors of mark to market fear, not without reason, that mark to market will force too many banks into insolvency, but there is a solution for that: Suspend the rules that force these insolvencies. In other words, let technically "insolvent" banks continue to operate as if they were solvent. Do I want to put out of business Jamie Dimon? No. But I want to know how badly his JPM is "stuck."

If a bank's capital ratios fall below certain minimums, regulators have the right, but not necessarily the obligation, to force those banks into insolvency. So let the government announce that under certain circumstances, and for a stipulated period of time, it will waive its "right" to force such banks into insolvency.

As an example of what I mean, we have a Treasury Secretary who had, shall we say, unpaid taxes for which the government could have prosecuted him but chose not to. I actually have a problem with this, but they make the rules. At least I know that we have a person of questionable tax compliance at the helm of the Treasury.