The other news from Washington focused on restoring the uptick rule and the adjustment of mark-to-market accounting. Both issues fall under the purview of the SEC. Congress notably ratcheted up the political pressure to adjust these policies. Representative Paul Kanjorski, who held Thursday’s subcommittee hearing on mark-to-market, set the tone early. “Take the case of the Federal Home Loan Bank of Atlanta. Last September the bank estimated that it would lose $44,000 in cash flows on three private label mortgage-backed securities starting in about 15 years. The magic of mark-to-market accounting required this relatively minor shortfall to be treated as an other than temporary impairment loss of $87.3 million. I find this accounting result to be absurd.” To be clear, almost none of the recent highly vocal critics are advocating suspension, instead, they are calling for additional guidelines on the application of the rule because, in Kanjorski’s words, “It fails to reflect the economic reality. We must correct the rules to prevent such gross distortions.” During the hearing, the House Members came down hard on FASB Chairman Robert Herz to give better guidance regarding Fair Value Accounting. Kanjorski made other market friendly comments, “Bank regulators must also consider liberalizing regulatory capital requirements and granting reasonable forbearance in the current economic environment.”
It is remarkable how history comes full circle. Prior to 1938, U.S. banks did adhere to mark-to-market, at the time it was called “Market Value Accounting.” In “Monetary History of the United States,” Milton Friedman and Anna Schwartz noted that “The impairment in the market value of assets held by banks, particularly in their bond portfolios, was the most important source of impairment of capital leading to banks suspensions, rather than the default of specific loans or specific bond issues.” And “Because there was an active market for bonds and continuous quotation of their prices, a bank’s capital was more likely to be impaired, in the judgment of bank examiners, when it held bonds that were expected to be, and were honored in full when due than when it held bonds for which there was no good market and few quotations. So long as the latter did not come due, they were likely to be carried on the books at face value; only actual defaults or postponement of payments would reduce the examiners’ evaluation. Paradoxically, therefore, assets regarded by the banks as particularly liquid and providing them with secondary reserve turned out to offer the most serious threat to their solvency.” (p. 355-356). Today, the banks do not even get the benefit that banks had in the 1930s for illiquid instruments. In response to the problems cited above as well as the pro-cyclical effects of write-ups in good times, the 1938 Uniform Agreement on Bank Supervisory Procedures was passed to adopt a historical cost basis for accounting for financial assets. In 1992, as the U.S. began its move to towards the mark-to-market accounting we have today, SEC Commissioner Richard Roberts gave the following explanation of what occurred in the 1930s, “The market value debate has a long history. In 1938, U.S. banking regulators agreed to adopt historical cost as the primary measurement attribute. Curiously enough, that agreement was reached largely out of concern with the effect that reporting market values would have on the behavior of depositors and investors, and on public confidence in our nation's banks. Since securities were said to be held for the long-term and because interest rates were stable and regulated, historical cost accounting worked fairly well and restored public confidence in the banking system after the economic crises of the 20s and the 30s.”
Mike O’Rourke, CMT
Chief Market Strategist Sphere: Related Content
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