Here's an interview I did for Bloomberg on Sept. 15. Click here.
Below is a piece I did for forbes.com. You can access it by clicking here.
Why Mark To Market?
Bob McTeer 09.15.08, 12:50 PM ET
I was afraid of accounting in school; I still am. Back then, I feared it would wreck my grade point average; today, I fear it will wreck our financial system.
It has come uncoupled from common sense. It's ceased being a tool for business and has become its master–and not a benevolent master at that. It's causing unnecessary failures of basically healthy businesses and contributing to the downward spiral of our credit markets.
I refer primarily to mark to market accounting, which forces firms to revalue their assets to current market values even when the market is frozen or dysfunctional and even when the assets could be held to maturity and redeemed at face value.
If a bank loan goes into default, it makes sense to write it off the books. If a borrower has missed several payments, it makes sense to set aside a provision for the likely loss. But if a security trades lower because market interest rates have risen or because of problems in the market itself, requiring an immediate write-down is unduly harsh, because capital is reduced by the same amount.
Because capital is usually, and legitimately, a small percentage of assets, capital can easily go to zero and a perfectly sound institution can be declared insolvent and taken over by its insurer or some other government agencies.
"Prompt corrective action," also adopted as one the "reforms" of the early 1990s, makes the matter worse by allowing the authorities to pull the trigger before capital reaches zero. Its purpose is to reduce the cost of "resolving" (read "taking over") troubled institutions, but what it amounts to is shooting the sick and wounded to expedite the burial. Efficiency and cost effectiveness trumps fairness.
Were Fannie Mae and Freddie Mac insolvent when the government took them over? Did their capital reach zero? I don't know, but I doubt it. It all depends on how much capital was reduced by marking assets to market. People will say management had an incentive to write their assets down to little. Granted, but might the government have had an incentive to mark them down too much to justify a "conservatorship," which was apparently its preferred solution?
As I write this, there is much discussion of private sector purchases of weakened financial institutions and the disincentive provided by the prospect of triggering mark-downs by doing so. The purchasee already has low marks, which will be inherited by the purchaser, in addition to which the ratings agencies are likely to downgrade the new entity and trigger other negative events.
Isn't it ironic, and galling, that the rating agencies helped create our current problems by looking through rose-colored glasses during the good times, and now they are exacerbating it by looking through their dark shades.
Mark to market rules and strict ratings may be appropriate (though unfair) in the good times as a means of preparing institutions for the bad times. That doesn't mean they should be rigidly applied or even tightened up during the bad times. Hard exercise may boost your immune system to help stave off disease. Hard exercise after the onset of the disease may not be such a good idea.
Critics of some mild regulatory forbearance during this most serious of crises since the Great Depression will no doubt cite transparency as essential, but the two can go together. I'm not advocating hiding temporarily impaired assets. They can remain on the balance sheet with a footnote explaining the intent to hold to maturity.
It is time for common sense to come before accounting purity and cut our losses. It's one thing to become a victim of a bad loan or a bad economy. It's quite another thing to become a victim of unnecessarily strict accounting rules.
Bob McTeer is a distinguished fellow at the National Center for Policy Analysis and former president of the Federal Reserve Bank of Dallas.