Bailout Update: SEC Changes Mark-to-Market Rule
In the first significant government act to address the financial crisis government caused, the Securities and Exchange Commission changed an accounting rule first imposed on American businesses seven years ago.
The Big Bailout is Government’s effort to solve the current crisis caused by millions of low quality mortgages, issued by the government founded and chartered mortgage companies, Fannie Mae and Freddie Mac, and required by government regulations to be issued by private sector institutions. These mortgages were bundled into securities and sold to the Wall Street banks and institutions that are now in trouble.
Compounding the problem is an accounting rule imposed by government regulators in the wake of the last “crisis” the stock market crash of 2000 – 2002 that politicians blamed on “wall street crooks like Enron.”
Called “fair value” or “mark-to-market,” this rule requires financial institutions that own the mortgage bonds to – on paper – “mark down” the value of the bonds to a theoretical market value, much lower than would be justified by the actual deterioration of the underlying individual mortgages.
This dramatic decline in the paper value of assets brought the end of Bear Sterns and the bankruptcy of Lehman Brothers, and has driven several other banks and institutions to the brink of insolvency.
Other government regulations put limits on the amount of money a bank can loan out, based on the value of the bank’s assets. The precipitous decline in the on-paper value of these mortgage assets over the past two years has led to the current crisis, rapidly declining credit available in the marketplace for routine business operations, mortgages, and consumer loans.
So why not change the Fair Value (mark-to-market) rule, you ask? Good question!
This rule is only seven years old. It didn’t come from the Constitution or the Bible. It wasn’t given to Moses on the mountain top. It’s an arbitrary rule, developed in a political process, to impress voters that their elected representatives could be “tough on Wall Street.”
Yesterday, the SEC did finally change the rule, about two years late. Here are some brief excerpts from the SEC announcement:
Washington, D.C., Sept. 30, 2008 — The current environment has made questions surrounding the determination of fair value particularly challenging for preparers, auditors, and users of financial information. The SEC’s Office of the Chief Accountant and the staff of the FASB have been engaged in extensive consultations with participants in the capital markets, including investors, preparers, and auditors, on the application of fair value measurements in the current market environment…
While the FASB is preparing to provide additional interpretative guidance, SEC staff and FASB staff are seeking to assist preparers and auditors by providing immediate clarifications…
Can management’s internal assumptions (e.g., expected cash flows) be used to measure fair value when relevant market evidence does not exist? Yes. When an active market for a security does not exist, the use of management estimates that incorporate current market participant expectations of future cash flows, and include appropriate risk premiums, is acceptable…
Do we still need The Big Bailout?
Maybe not. Maybe it can be smaller than originally envisioned. Nobody knows yet, and the politicians aren’t waiting to find out. Prudence is unknown in Washington.
The Senate is already preparing to vote today on a hastily thrown together modification of the Bill that was voted down in the House on Monday. Fasten your seat belts. The self appointed Smartest Politicians on Earth are about to take us on a wild ride.
