Last week, the New England-based Financial Accounting Standards Board swooned under pressure from Congress and the banking industry, and changed its rules regarding how companies must value assets on their books. Bankers hailed the change as a win – and the stock market soared because of it – but we’ll see whether this proves to be the game changer it’s been touted as.
The rule is called “mark-to-market.” It forces companies to recognize in their public financial statements the true value of assets on their books. Let’s say a corporation buys another small company for $1 million. Then that small company loses all its customers, and all its market share. The corporation can’t claim on its books that the smaller company is still worth a million bucks. It has to mark the asset down to its true market value.
It should be noted that this rule really gained steam after the Enron debacle, a company at which the books were so cooked that rigid accounting principles were turned into limp noodles. When a company can value its assets any way it wants, there’s simply no way to tell its true financial stability.
But the flaw in “mark-to-market” is that there needs to be a market by which to judge an asset’s value. And for mortgage-backed securities and other financial instruments, those markets no longer exist or function adequately. That’s one of the big reasons why banks have reported such big losses: it’s not that so many of their mortgage loans have soured, it’s just that there’s no market in which to sell them. Thus do performing loans get classified as worthless clunkers on a bank’s books.
The rule change will allow banks to assign a value to these loans based on, essentially, the bank’s best guess of what they might be worth if someone were willing to buy them. But the banks can only do this on assets they intend to hold until a market forms (but they don’t have to promise to do so).
That makes “valuation” of these assets a rather squishy proposition, and it’s not hard to see a lot of investor lawsuits headed toward lenders whose “guesses” prove inaccurate and misleading.
Whether the rule change will really help depends on whether bankers can justify that these assets have significantly more value than is now reflected on the books. Part of that valuation has to be not just whether someone, somewhere will actually be willing to buy these loans, but what is the actual underlying value of the loans themselves.
In the same week that FASB told bankers they could start fashioning their own valuations, here’s what else happened: Fannie Mae and Freddie Mac issued a strong cautionary note that they’re seeing big upticks and record numbers for delinquency rates on prime mortgages; the nation’s unemployment rate surged to shocking levels; consumer confidence in New England plummeted to its lowest level ever recorded; delinquency levels on business loans rose from 3.91 percent in December to 4.5 percent in February, a pace that will lead to an overall 8 percent rate by year’s end if there’s no abatement; and initial foreclosure filings in Massachusetts posted their fourth straight month-over-month increase. Oh, and the Federal Home Loan Bank of Boston said that, on taking a harder look at its own portfolio of mortgage backed securities, it’s probably going to have to recognize an even bigger 2008 loss than the $73.2 million hit already taken.
Mark-to-market may be gone. Mark-to-fantasy shouldn’t be its replacement. If bankers are valuing their portfolios using solid financial benchmarks, they’ll see some financial gain. But in the short term, at least, optimism in the financial statements ought to be tempered by economic reality.â–
