A Glimmer of Fiscal Sanity

Today’s New York Times reports that the Financial Accounting Standards Board (FASB) voted today to relax strict application of mark-to-market regulations, such as Financial Accounting Standard 157, regarding the valuation of mortgage-backed securities.

Skipping past the first six paragraphs insinuating that this is a bad idea and that the independent FASB was pressured into it:

The banks have argued that the market values of some securities, principally mortgage-backed securities, are now far below the real value that will be realized over time. They argue that being forced to take such losses has hurt their capital positions and worsened the financial crisis.

Banks have long been required to value some assets at their current market value, but the rule has provided an exception allowing banks to disregard “distress” sales that do not accurately reflect real market values.

This is the point. Like a funhouse mirror at the circus, the FASB mark-to-market regulations give a distorted picture of asset values: too high in boom years; too low during bust cycles. These accounting rules helped facilitate the Enron scandal by supporting inflated asset prices during those more exuberant times. When the housing bubble burst, the same rules required banks to value mortgage assets at distress sale prices, even when the underlying loans were still performing. This resulted in a significant undervaluation of commercial mortgage-backed securities, and as a consequence, a loss of liquidity to many banks, and a domino effect threat to the entire banking system.

Today’s stock market rally should be seen as a favorable response to the new less rigorous guidelines. Finally, a small but significant step in the right direction to fix the problems affecting the banking system. The first rule of holes is “when you’re in one, stop digging.” Today, the FASB decided it was time to stop digging.

Those who blame the financial mess on “deregulation” should ask themselves why today’s FASB decision to relax/suspend stringent application of FAS regulations caused the stock markets to soar rather than sink today. We shall see if the markets react as favorably when this spelunking Congress enacts “cap-and-trade” legislation.


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