Friday, March 13, 2009

I think this is how reading too much news makes you think you know shit about something you really know nothing about...

The National Review is a publication that I reflexively dismiss because most of what it publishes is agenda-driven rationalization of right wing policy. But I read it because I think its very important to take seriously and understand viewpoints that I reject, so that I have good reasons for rejecting them.

Mark-to-market accounting practices are a great example of a policy towards which I have been mostly a committed partisan. In a nutshell, these are accounting practices that require businesses to value their assets at prices determined by the market, rather than pegging them at some arbitrary "real value," which could be used to make balance sheets appear more healthy than they actually are. A big cause of the solvency crisis in finance right now was supposedly over-leveraging of assets to absurdly risky proportions. Suspending mark-to-market accounting practices would allow businesses to spruce up their balance sheets, but at the expense of having those balance sheets mean anything.

But, here comes a National Review article with a surprisingly substantive argument. When articles are credited "to the editors" this is rare.

"The problem is this: Under mark-to-market rules, a bank must readjust the value of the assets it is holding to reflect current market prices. For some kinds of assets — especially mortgage-backed securities and other real-estate products — those market prices have declined well past the point at which the banks would agree to sell them. We are reflexively skeptical of any argument that there is a “real price” that is different from the market price, but in this case the distinction is plausible."

This argument acknowledges the weakness of the notion of a "real price" to which assets can be pegged. But it disputes that the market should determine the value of assets because the market is acting in a misleading way. But this claim hinges on a further justification.

"These assets generate income, and that income makes them worth more to the banks than buyers on the market would currently be willing to pay. Under the current rules, that doesn’t matter, and the assets’ value has to be adjusted to account for what the rules describe as a “hypothetical transaction at the measurement date.”"

That is, that there is a tangible value to the asset in that they "generate income" that is greater than the market price. This seems to be a pretty flimsy assertion. How many of the assets that are likely to be re-valued under a suspension of mark to market would meet this condition- that they generate more income than the price at which the market values them? And how can this price be determined without allowing banks deceptive leeway in doctoring their balance sheets?

BUT moreover, there is a second, justification for suspending mark to market: that these accounting practices are bad for business in the midst of a recession. The NR again:

"...banks have to treat losses on paper as though they were real economic losses, accepting fire-sale valuations of securities that they may not intend to sell. The second is that, because mark-to-market rules are used in assessing banks’ capital requirements, those paper losses can quickly become real losses when banks are forced to sell assets, often at an enormous loss, to raise enough capital to keep the regulators satisfied. Those pressured sales, in addition to locking in losses, tend to drive down the prices of similar assets, creating a vicious cycle of wealth destruction. The market becomes a snake swallowing its own tail."

So, interesting questions are raised. Like, if suspending mark to market would really help a bank lurch towards solvency, wouldn't this be an alternative to endless bailouts in helping revive the financial sector? I have nowhere near enough knowledge to know whether or not this might be true, but I think the questions that must be raised against the National Review article are pretty crucial. Like, yes, less regulation does foster a more hospitable business climate. We could decrease capital requirements for banks too. But these sorts of practices are the sorts of things that got us here. Mark to market may just be another practice that needs to stay to damper down the propensity of a "profit at all costs" structure to gleefully escalate its risk to terrifying proportions.

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