Financial markets are frozen throughout the world, and former FDIC Chair William Isaac puts the blame squarely on the Securities and Exchange Commission and fair-value accounting—especially the accounting method's requirement that banks "mark to market" their assets.
"The SEC has destroyed $500 billion of bank capital by its senseless marking to market of these assets for which there is no market, and that has destroyed $5 trillion of bank lending," he said.
"That’s a major issue in the credit crunch we’re in right now. The banks just don’t have the capital to start lending right now, because of these horrendous markdowns that the SEC’s approach required."
Friday, October 10, 2008
Former FDIC chairman: Mark-to-market causing credit crunch
In a CNBC interview, a former FDIC chairman blamed mark-to-market accounting for the credit crunch:
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Ah, I see the problem! The banks actually have to tell the truth! The balance sheets would look oh so much better if the banks could arbitrarily assign a value to their assets.
ReplyDeleteso how can they suspend mark-to-market when the cash flow is not there from those assets and the MBS insurers start going bankrupt from having to payout to cover the defaults?
ReplyDeletei guess i just don't get how suspending reality and marking to fantasy land will bring confidence back.
nor do i understand how the new Fed policy to pay interest on banks' reserves held at the Fed will promote lending when those banks can just keep their money at the Fed and get a guaranteed return as opposed to lending during a recession.
Blaming the credit crunch on mark to market accounting is like blaming the weather on the guy who records the day's temperatures in his weather journal.
ReplyDeleteguy said: "i guess i just don't get how suspending reality and marking to fantasy land will bring confidence back."
ReplyDeleteThere was a terrific quote in the Wall St. Journal the other day that went something like:
"Strong balance sheets create confidence. It doesn't work the other way around."
guy n. cognito said...
ReplyDelete"nor do i understand how the new Fed policy to pay interest on banks' reserves held at the Fed will promote lending when those banks can just keep their money at the Fed and get a guaranteed return as opposed to lending during a recession."
I don't understand this in detail. I'll have to study it. I think it's intended to give the Fed better control over interest rates when they approach zero. It is intended to prevent a liquidity trap.
guy n. cognito said...
ReplyDelete"i guess i just don't get how suspending reality and marking to fantasy land will bring confidence back."
Let me try to explain it this way. There is often a difference between an asset's long term value and its short term value. Just as bubbles are created by irrational exuberance, financial panics are caused by irrational fear. Prices set during a panic are no better a representation of long term value than prices set during a bubble. Just as bubbles are self-reinforcing, as momentum investors chase the market up, panics are also self-reinforcing as deleveraging and a flight to safety forces the market down.
Let me also add that many visitors to this blog believe that asset bubbles can exist, and that prices set during a bubble do not represent the long term value of a house, stock, bond, etc. For those of us who believe in bubbles, it would be intellectually inconsistent to believe that their opposite cannot also occur.
Of course, there is a danger that financial institutions will engage in an "always up" mentality, preferring to use market value when market prices are high, and intrinsic value when market prices are low. However, William Isaac made it clear during the CNBC interview that he always opposes mark-to-market accounting.
These assets are worth what the market will pay for them nothing more nothing less.
ReplyDeleteThe point is what would you invest in? If it was your money would you pay more? By all means go ahead if that's the case. But if you will, why not everyone else? Well then we have a new market price don't we?
The anti-mark to market accounting people are in my view the same people that try and talk about "unrealized losses." There's no such thing. A loss is a loss.
Just a question. how does this fair value accounting exactly affect??. Secondly what would have happened if the economy/asset value had an up turn instead of a down turn?
ReplyDelete