Moderated by Rick Badie
Today we discuss the mark-to-market, or fair value, accounting rule. It requires banks to record the price or value of a security, portfolio or account to reflect current market value. A guest columnist, who is not writing in his role as a bank executive, says the rule may have caused many banks to fail and should be suspended. I interview Jack T. Ciesielski, a Baltimore money manager who says the regulation improves transparency and shows financial weaknesses.
Fair value reporting is meaninful reform
By Rick Badie
Q: Explain the mark-to-market rule.
A: Adjusting the value of financial instrument holdings to market price is the accounting practice known as “mark-to-market.” It’s the same way workers preparing for retirement look at their 401(k) plans: They can do something only with what they’re worth at a certain point in time. It’s their current value that matters to their plans, not the amount they invested. It’s more accurate to call it “fair value reporting” in financial statements for investors.
Q: When did it start being applied to banks?
A: You can find the principles in accounting standards as far back as 1947. About five years ago, the Financial Accounting Standards Board (FASB) made a change to the disclosures about financial instruments under fair value accounting. It did not extend it to new instruments or change the accounting, just the disclosures. It required firms to tell investors about the fair values used in the reporting: whether they came from security prices found in an active market, or estimated from similar securities traded in an active market, or whether they were based purely on an estimated value because there was no market.
Q: Why are banks opposed to it?
A: I think they are always afraid it would be extended further, to originated loans. Greater visibility into credit quality of loans might make for a tighter market leash on their activity. Concern over stock prices — and they’re highly compensated with stock — might make bankers more conservative in lending and acquiring. And I think they’re afraid the regulators might continue to work in more of FASB’s accounting definitions into their own definitions of capital.
Q: How does the rule benefit consumers?
A: Fair value reporting gives relevant information to investors that helps them make better investment decisions. The historical cost of investment decisions doesn’t tell investors how well managers have performed with shareholder capital. If fair value reporting shows that financial institutions have been reckless in allocating their shareholders’ capital, securities of those firms will show investors’ displeasure. Conversely, if fair value reporting shows that financial institutions have wisely allocated shareholder capital, the securities of those firms will reflect investor enthusiasm. Fair value reporting enables investors to evaluate how well managers perform and makes markets function better. When capital markets function properly, everybody benefits.
Q: Should this regulation be suspended?
A: For investor reporting, I think it should be expanded, not scaled back.
Q: If tweaked to suit the banking industry, what happens?
A: More of the same: poor transparency into how managers have done their job of investing shareholder capital, and resulting poor market oversight of managers through stock prices. I hope you can see that it’s a slightly, but not hopelessly, complicated set of reporting standards. … The banks have a huge amount of sway . … They’ve used that sway to keep meaningful bank reforms at bay. Fair value reporting is one of them.
Bank regulations hurt more than help
By Danny Jett
Barney Frank, the retiring Massachusetts congressman and former chairman of the House Financial Services Committee, recently admitted that the Durbin Amendment, which was part of the 2010 Wall Street Reform and Consumer Financial Protection Act, is unlikely to help consumers.
The amendment sets caps on interchange fees that banks can charge when consumers use debit cards. Many banks have eliminated free checking accounts to make up for the lost revenue. Few retailers, however, have passed their savings along to consumers.
If Frank, who was known throughout his 30-year political career as a harsh critic of the banking industry, is willing to admit that regulations he earlier supported are failing to help consumers, then perhaps it is time for those still serving to follow suit and rethink other regulations. A good start would be the mark-to-market accounting rule, which requires banks to immediately write down declines in real estate values, even if the mortgages financing those real estate holdings are being paid in full. The rule was created in the wake of the Enron collapse for the volatile world of commodities trading, but was applied to banks and real estate assets, which typically change on a yearly basis.
Research conducted by Joey Smith and others at the University of West Georgia’s Richards College of Business suggests the mark-to-market rule is having a detrimental impact on Georgia communities. Many banks could have survived were it not for the rule. More than 80 banks have failed since 2008.
As of March 2010, 25 percent fewer jobs were available at Federal Deposit Insurance Corp.-insured institutions in Georgia compared with the first quarter of 2006. The job losses were not limited to those working in the banking industry. According to Smith’s research, for every job that disappeared in banking, 1.26 jobs were lost in supporting industries. Georgia has shed about 36,300 jobs attributable to the financial crisis. Large cities may be able to absorb employment declines in financial services, but smaller communities cannot cope as well.
When fewer banks are lending money, residential and commercial property values decline. State sales tax revenue in Georgia decreased $93 million. This scenario is being played out at the state and local level.
A 2010 Federal Reserve study found that 2009 was the first year state and local taxes fell in nominal terms since the Great Depression. Governments are strapped for cash and looking to save money. The National League of Cities conducted a survey of city finance officers in 2011, and more than 40 percent said their cities were cutting services.
The financial recovery will continue to be a slog if elected leaders do not take stock of which regulations work and which don’t. Reforming the mark-to-market rule could be done at no cost to taxpayers. There is little downside, but a significant upside for community banks and Georgia towns that rely on them for small business loans, jobs and tax revenue.
Danny Jett is a founding member of Main Street Solutions and CEO of Douglas County Bank.