Bean Counting Breakthrough Boosts Bourses

Quasi-governmental good news for a change.

The so-called “mark to market” accounting rule helped to deepen the financial crisis but the Financial Accounting Standards Board decided today to ease the accounting fiat –and voila— the Dow Jones Industrial Average closed 216 points higher than the previous close. According to a report in the Friday edition of the Independent (UK)

Banks in the US are being given more discretion on how to value the toxic mortgage assets that have poisoned their balance sheets in a reversal of parts of the controversial “mark-to-market” accounting rules that many blame for exacerbating the credit crisis.

The Financial Accounting Standards Board (FASB) voted yesterday to let banks ignore market prices for assets if they judge the market is illiquid and that the most recent sales are being done at firesale prices by distressed sellers. There will also be changes to allow banks to book smaller losses on impaired assets that are available for sale, which could take extra pressure off many of the biggest banks in the US.

Traders put yesterday’s dramatic rally by global equity markets down to the relaxation. […]

The FASB was acting under pressure from Congress, which said it may legislate if the board did not ease the rules.

The Centre for Investors and Entrepreneurs [at the Competitive Enterprise Institute], which has been campaigning for a suspension of mark-to- market accounting, welcomed the move. Its director, John Berlau, said: “By itself, this change will not make the price of mortgage assets higher or lower. Rather, it will allow price discovery to occur. Mark-to-market distorted the market by forcing banks to take losses on mortgage assets even if the underlying loans were still performing.” […]

Back when the stock market crashed in September, Berlau opined that repealing mark to market would have a salutary effect on markets. (Berlau’s full Wall Street Journal article is available here.)

Investors Business Daily editorialized today that the mark to market rule, imposed on banks in 2007, forced them to mark down long-term assets as if they were short-term based on present market conditions. The rule “severely damaged banks’ balance sheets, forcing them to shrink capital and rein in lending.” Bank assets “have had to be marked down to market value even if loans are being paid on time.” IBD continued:

From the late 1930s to 2007, the U.S. banking system was reasonably stable, with a few exceptions. One big reason for this is the absence of mark-to-market.

The change of heart from FASB on mark-to-market was largely due to Congress. We’re happy to report that bipartisan pressure undid the bad rule – a rare thing these days.

Mark-to-market rules, while well intended, have historically been a problem. During the Depression, Nobel-winning economist Milton Friedman noted, mark-to-market rules caused many banks to fail. That’s why FDR repealed them in 1938. Those rules had remained dead until two years ago, when they were reimposed as part of a frenzy of ill-considered financial reregulation.