FASB Looks to Expand Mark-to-Market Rules

The Wall Street Journal reported today that the Financial Accounting Standards Board ("FASB") is looking to expand requirements for mark-to-market accounting at banks.  If successful, the FASB will require banks to report the market values of loans rather than the historical cost.  This change could have a dramatic impact on the balance sheets and income statements for many financial institutions.  Here is some additional perspective from the WSJ.

Banks generally loathe mark-to-market rules, which rely on what they feel are too-often irrational market prices. The market value of some loans did fall excessively in the depths of the crisis. And many bankers, and bank regulators, believe the rules worsened the financial crisis.

But that argument ignores the fact that banks clearly didn't pay enough heed of market values in the run up to the crisis, and their own estimates of potential losses were woefully inadequate. This left bank balance sheets, and investors, unprepared for the credit crunch. If banks had focused on market values as well as internal models, many may have acted sooner to raise equity.

If these new rules are adopted, then the divide between the winners and losers among financial institutions will widen precipitously.  Investors and bankers alike will be keeping a close eye on this potential development.

Mark-to-Market Mess

Former Federal Reserve Chairman Paul Volcker recently provided some interesting insight into the role of mark-to-market accounting in the current economic crisis.  In a speech to the International Institute of Finance, Mr. Volcker noted the following.

There isn't much doubt that attempts to enforce strict application of mark-to-market accounting procedures has contributed to confusion, uncertainty and inconsistencies among financial institutions. There is a strong case for reviewing the application of so-called fair value standards to commercial banks, insurance companies and perhaps certain other regulated financial institutions.

The problem is not only the difficulty of measuring value in highly disturbed market conditions. More broadly, strict mark-to-market accounting -- entirely appropriate for trading operations and investment banks -- may introduce a degree of volatility in reporting incompatible with the basic and essential business model of banks, which inherently intermediate maturity and credit risks.

There is no doubt that mark-to-market accounting contributed to the death spiral of many institutions as they tried to mark positions to a market that temporarily ceased to exist.  While mark-to-market accounting is noteworthy in its attempts to provide greater transparency, it currently possesses some very serious unintended consequences that must be rectified.