Is the the credit crunch just an accounting issue?
During the debate Monday morning on the bailout bill, one conservative Republican after another denounced the bill. We don’t need $700 billion to fix the problem, they said. Instead, the real solution is the repeal of a specific accounting rule. The accounting rule, FASB Statement #115, first promulgated in 1993, requires financial institutions to assess their holdings according to whatever price the market currently values them at. This is known as the “mark-to-market” rule. Since right now, no one wants to buy mortgage-backed securities or their derivatives, the assumed market price is very low, thus causing tremendous balance sheet problems for their owners. But according to the Republicans, the “real” value of these assets is much higher, and if the “mark-to-market” rule were dropped, and companies could tot up the assets according to some measure of intrinsic value, voila — everybody would be in back in black, the credit markets would unfreeze, and the crisis would be over.
During the debate Monday morning on the bailout bill, one conservative Republican after another denounced the bill. We don’t need $700 billion to fix the problem, they said. Instead, the real solution is the repeal of a specific accounting rule. The accounting rule, FASB Statement #115, first promulgated in 1993, requires financial institutions to assess their holdings according to whatever price the market currently values them at. This is known as the “mark-to-market” rule. Since right now, no one wants to buy mortgage-backed securities or their derivatives, the assumed market price is very low, thus causing tremendous balance sheet problems for their owners. But according to the Republicans, the “real” value of these assets is much higher, and if the “mark-to-market” rule were dropped, and companies could tot up the assets according to some measure of intrinsic value, voila — everybody would be in back in black, the credit markets would unfreeze, and the crisis would be over. This
Mark to market is only supposed to be used on “available for sale” securities. The reason for the FASB’s decision on this was that companys held short term investments as cash equivalents, so on balance sheets they are closer to cash. At the end of the year, their balance has to be revaluated, and the resulting gain or loss on available for sale securities is recorded along with the new value. Generally the rule of thumb is securities intended to be held for under one year are available for sale. Any other securities are to be held to BE RECORDED AT COST. It was intended that most companies have longer interests, so the majority of securities would be held for a while and then they are sold with the gain recorded at sale. No company was intended to have the majority of their security holdings evaluated as available for sale. My guess is that they saw a way to milk income on the balance sheet, by classifying everything as available for sale, and seeing a gain every year. In that case, n
