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Is the New Mark-to-Market Rule a Good Remedy?

The new accounting rule for banks is hailed by many as a toxic asset-remedy but others believe it still has its flaws.

The New York Post ran a timely feature on the criticisms against the mark-to-market accounting rule. Chris Whalen, managing director of Institutional Risk Analytics said to the Post, “Prudent bankers will not mark these assets back up, but will keep the money in the cookie jar through 2009 until we see the loss rates peak.” The report adds, “Former Securities and Exchange Commission Chairman Harvey Pitt sees the accounting rule change as ‘Smoke and mirrors, to make the banks’ balance sheets look better. This is just a cosmetic change.'”

So what’s the fuss behind this esoteric accounting rule? The mark-to-market standard has been blamed as one factor that caused the current banking crisis. In simple terms, this rule forces banks to declare the value of their assets in terms of current net worth. Banks that are holding toxic mortgaged-backed securities are therefore required to write-down their net value so their balance sheets are obviously deteriorated and investors, though informed of a company’s present financial performance, would turn away from putting their money in the firm.

The mark-to-market rule modification this time involves banks that hold toxic paper on their balance sheets to declare these at a fair market price so they can reduce the capital requirement that will be used to offset the previous depressed values. But some are in favor of the change. Richard Berg, CEO of Performance Trust Capital Partners and a staunch supporter of the mark-to-market rule, joined the debate in CNBC Power Lunch last week. Click on the video below to watch how banks can turn out to be more willing to lend this time.

Berg may have a point but nevertheless, but notice the issue on the government’s role in the crisis that prevails in their arguments? In a letter from economist Jeff Hummel posted on David Henderson’s Library of Economics & Liberty blog, this issue is clarified. Hummel opines, “… thanks to various government interventions, banks operated with the minimum capital required by the mark-to-market application of the law, consisting almost entirely of artificially created AAA securities benefiting from artificially high market pricing resulting from sloppy ratings. And then reality bit, and an honest revaluation of these securities based on mark-to-market accounting, linked to inflexible government regulations, brought down the banking industry. And that is the extent to which I believe mark-to-market accounting can be blamed for this crisis.”

This is a controversial issue indeed. If advocates are aiming for healthier financial reports on banks so investors would be enticed to get back on track, it still won’t get over the fact of the true nature of sour real estate loans. If on the other hand, things turn out as planned, wouldn’t it raise mortgage rates instead since the Treasury bond market will see fewer demand and offer higher yields leading mortgage rates to rise as well since investors would shift money to riskier financial markets?

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