Printer-Friendly Version Page 1 of 2
Reform Mark-to-Market Rule
Sunday, Oct 05, 2008 - 12:05 AM
By RICHARD TULLO
Iwrite not as a Democrat or Republican and not from Wall Street or from Main Street but as an American with the health and well-being of
this country as my only project. My take on the financial situation: The bank crisis is a perfect storm owing to the complex math,
government regulations, and exotic securities that have caused it.
The basic problem is caused by bad laws that allowed a few bad apples on Main Street to take loans they could not pay back and a few
bad apples on Wall Street to make loans that they knew were bad in order to make a bonus check.
At the end of the day the banks got stuck holding the bag because Wall Street borrowed money from the banks. The government has to fix
the problem because both Democrats and Republicans created it, and it will cost as much as $700 billion.
While Congress calls the Treasury's plan a bailout, it is not a bailout but an investment in America. If the plan works, the government will
own mortgages on some Main Street houses as it pays 20 cents for the mortgages and sells most of them to investors for 40 cents.
It's a practical plan in theory since losses to taxpayers for the few mortgages that will go bad will be offset by the profits government makes
on the rest. By most estimates the mortgages are worth more than 40 cents on the dollar.
While the Treasury package fixes one issue, the failures that got us to this crisis still exist. FASB is a rule-making board created by
Congress to issue the accounting rules that are called generally accepted accounting principles, or GAAP. Lack of congressional oversight
on FASB and other ineffective regulations contributed to the current crisis.
For example, mark-to-market accounting is the result of FASB rule 157, which basically states that a security should be valued at the last
sale -- no matter what the intrinsic value (or realistic value) of that security is in the real world. FASB 157 was introduced in part because
hedge funds and corporations were using marks to inflate balance sheets and carried interest. So suspending mark-to-market completely
can create other problems.
However, when applied to banking institutions, FASB 157 results in losses -- and banks cannot make loans to corporations, governments,
small business operators, and consumers. FASB should be in business to protect investors and prevent bankruptcies -- not in the business
of making rules that kill business and investors, as it did with Rule 157 and Lehman Brothers.
One solution to the crisis would be to improve mark-to-market accounting. While an improvement to FASB 157 would not reverse the
current problem, reform of FASB 157 would quarantine the crisis to the mortgage market and buttress the foundation of the banking
If securities are marked to the call price (the price where a bank would sell them), then the downward spiral could reverse for mortgage
securities. Marking securities to the call as the basis of balance sheet valuation is a better alternative to the current rule, which uses last
sale or bid to determine price -- because bids can go to zero and the financial failures will cause some bonds to sell for nearly zero in a
foreclosure-like (or distressed) sale.
Marking to an ask or call price will (1) result in prices closer to the intrinsic value of these securities; (2) support the market created by the
Treasury for these securities; (3) create transparency in pricing; (4) encourage banks to sell securities; and (5) give investors an
opportunity to bid for securities with the government.
As Americans, we need reform because the Treasury plan can only take a sick American economy off life-support. A complete overhaul of
securities regulations is needed, as there are many rules such FASB 157 that create bigger problems than the ones they address.
As we look forward I am optimistic because I believe new regulation will be designed to offer investors stable markets that disperse risk
across a vibrant community of small but healthy private investment banks. This is the system that created the Reagan economic boom,
and the Dow Jones Industrials went from 1,000 to 3,000 during his presidency.
More important, the engines of our economy -- Microsoft, Home Depot, Intel, Dell, and Amgen, just to name a few -- were born of this
simple yet elegant system.