Among the 451 pages of provisions contained in the Senate-approved Emergency Economic Stabilization Bill of 2008, which the House will debate today, is one re-iterating the Securities and Exchange Commission’s (SEC) ability to suspend “mark-to-market,” or “fair value,” accounting rules. 

The Senate thus put further pressure to institute practices decried by the Department of the Treasury, and numerous analyst, economics and accounting groups, which allow companies and financial institutions to report the value of their assets on the price paid  – or even predicted or model generated – instead of current market prices.
 
“Suspending the mark-to-market prices is the most irresponsible thing to do,” Diane Garnick, a strategist at the major investment firm Invesco Ltd. in New York, told Bloomberg News. “Accounting does not make corporate earnings or balance sheets more volatile. Accounting just increases the transparency of volatility in earnings.”
 
These “mark-to-market” rules have evolved since the Savings and Loan (S&L) crisis of the 1980’s, as well as questions arising in the last two years on how much mortgage-backed securities are actually worth, to press companies and financial institutions to disclose how they set the value of what they own and avoid overly creative prices.

Several House Republicans claimed that their reasoning for rejecting the original “bailout” bill in the House was that it did not call for ending “mark-to-market” accounting and that they are closer to approving the new bill because of the concession. Lobby groups such as the American Bankers Association and the mortgage lenders’ Consumer Mortgage Corporation, as well as companies such as American International Group (AIG), have also pressed Congress and the SEC for a full moratorium.
 
House Republican Leader Rep. John Boehner, (R-Kansas), said in a statement, “Onerous mark-to-market rules for certain financial assets that have no market value have worsened the credit crisis, and changing them has been a priority for House Republicans.”
 
Republican Presidential Nominee John McCain’s economic advisor, Douglas Holtz-Eakin, said in a statement, “There is serious concern that these accounting rules are worsening the credit crunch, making it difficult for small businesses to stay afloat and squeezing family budgets.”
 
Holtz-Eakin’s release also noted, though, that McCain was “pleased to see” that the SEC and Fair Accounting Standards Board (FASB) have loosened the pricing rules Sept. 30 – right when quarterly earnings reports were due -  to take into consideration the falling or “inactive” market,
 
Former Speaker of the House Newt Gingrich has launched a media campaign claiming that the end of “mark-to-market” is the first step in the road to economic recovery. Gingrich noted this move should be the first in a conservative economic package, to be followed by repealing capital gains taxes and other post-Enron accounting requirements, as well as instituting a corporate flat tax.
 
The Treasury and Federal Reserve, as well as other economists, financial analysts, accounting firms and consumer groups, have continued to stress widely in the press that the current crisis is unrelated to “mark-to-market” principles and further restricting the rules would only cover-up or even exacerbate the crisis.
 
“Suspending mark-to-market accounting, in essence, suspends reality,” Beth Brooke, global vice chair at Ernst & Young LLP, told the Wall Street Journal Monday.
 
Marking to Model or Marking-to-Make Believe?
 
One alternative to “mark-to-market,” in the case of finance, allows banks to create computer or complex mathematical models to predict how much assets are worth. This was done in many of securities now being discussed, also known as Collateralized Debt Obligations (CDO’s), which intricately repackaged and sold stakes in mortgages and many other kinds of debts to investors.  Since investment banks claimed that a market did not exist in the traditional way, many firms created their own models to give these “exotic” or “esoteric” debt securities a price.
 
The “mark-to-model” – sometimes referred to as “mark-to-make believe” by critics – is not illegal and in fact permissible under current rules, so long as the company discloses that a model was used and places them in a certain category.
 
Berkshire Hathaway’s Warren Buffett critiqued this “mark-to-model” idea as being able to hide a company’s troubles, especially in the case of CDO’s, in his CNN Money commentary. “The recent meltdown in much of the debt market, moreover, has transformed this [mark-to-model] process into marking to myth…Indeed, for a few institutions, the difference in valuations is the difference between what purports to be robust health and insolvency.”
 
As early as 2006, certain analysts and academics began citing the problems with this model-based system and CDOs, predicting the tremendous risks to groups like the now-failed Bear Stearns. “These models end up breaking down rather dramatically during abnormal times,” said Andrew Lo, a finance professor at Massachusetts Institute of Technology, in July 2007.
 
Proponents of “fair value” accounting also highlight the role that inflated values played in Japan’s economic troubles throughout the 1990’s. A study by the Institute of Economic Research in Tokyo highlights how non-transparent accounting and pricing practices allow for “inefficient, debt-ridden” companies, called “zombie firms,” to continue to drain the economy.

“We have all seen what can happen when institutions are allowed to mask huge losses in asset values,” PricewaterhouseCoopers LLC Chairman Dennis Nally wrote in a letter to Congress. He noted that suspending the rules could “plant the seeds for the next crisis.”
 
From Savings and Loans Crises to “Fair Value” Accounting
 
While “mark-to-market” rules have been mulled in the U.S. since the 1960’s, they were first cemented in Financial Accounting Standards Board (FASB)’s Statement No. 107 in December 1991, which required that companies disclose the fair value of what they own.
 
This 1991 rule was a response to the Savings & Loan (S&L) crisis of the 1980’s in the United States, which costs the U.S. government over $124 billion. The large gap between the values S&L’s reported and their actual worth led to their sudden collapse, according to analysis in the St. Louis Federal Reserve Review.
 
Other corporate scandals such as Enron have led to more stringent accounting and auditing rules, such as the Sarbanes-Oxley Act of 2002.  
 
The focus on the “mark-to-market” rule came as a response to more questions regarding the debt-backed CDOs and other complex financing that has become so popular in the last decade. In January of this year, the SEC and FASB’s Statement of Fair Accounting Standards (SFAS) 157 streamlined “mark-to-market” rules. SFAS 157 required companies broader disclosure rules on how their values were determined and stress the value of market-based prices.                     
 
But this harder line has prompted further lobbying that culminated this week. Financial industry lobbyists had pressured shifts of this new rule as early as March 2008, when the first news of the credit crunch hit and quarterly earning reports were due. During this time, the SEC stressed that companies did not have to mark to markets where “forced liquidation or distress sales prices” occurred, i.e. where investors were selling off their securities at “fire sale” prices.
 
The SEC also released additional “clarification” Sept. 30, which stresses that in an “inactive market,” companies can “incorporate current market participant expectations of future cash flows, and include appropriate risk premiums” and utilize “multiple inputs” to determine a fair value.
 
The Federal Reserve, while generally calling for maintaining “fair value” accounting, also expressed the potentials for exemptions when the government will purchase the mortgage-backed securities as part of the $700 billion “bailout” bill. Speaking before the Senate Banking Committee on Sept. 23, Federal Reserve Chairman Ben Bernanke noted that in order to encourage finance sector participation in the buy-off the government should buy these toxic assets at their “hold-to-maturity” rate, i.e. to assume that the mortgages and pother underlying debt will get paid off and not buy at the crashing prices.
 
The FASB is also currently fast-tracking a new guidance to cement the clarifications it has already issued with the SEC. With the pressure from pending legislation in the Bill before the House, it is unknown how far these proposals will go towards altering “mark-to-market” accounting practices and how strongly the FASB will hold to its previous commitments.

Robert Chlala is a freelance journalist based in Los Angeles. For nearly a decade, he has worked in policy and communications with non-governmental organizations dealing with the Middle East, international law, immigration and other pressing issues. He can be reached at robert.chlala@gmail.com