If there is one profession that has an even duller and boring reputation than economists, it is accounting. So, who would have thought that in the current ongoing financial crisis one of the most passionate debates raging is about an accounting rule? Should we abolish or not mark-to-market accounting.
This rule stipulating that the value of an asset on a balance sheet should correspond to the current market price of the asset, or the price of similar assets. At a first glance nothing seems more innocent than this. Still, many experts believe that this rule has exacerbated market volatility and, if it has not caused the current financial crisis, at least deepened it.
How so? When the price of an asset starts to fall, it can lead to stress on the balance sheets of financial institutions forcing them to sell the assets to avoid further losses. But if everyone sells at the same time and there are too few buyers, the price of the asset becomes further depressed, precipitating even more forced selling and amplifying the downward spiral.
Acknowledging this problem in the US, the Emergency Economic Stabilization Act of 2008 (the bill that founded the Troubled Asset Relief Program, TARP) explicitly stated that the Securities and Exchange Commission (SEC) has the authority to suspend the mark-to-market rule if it determines that this suspension is in the public interest and protects investors.
However, there are risks to suspending or even abolishing this rule right now. First and foremost, such a measure could be interpreted by the public as a scheme to blur what financial intermediaries are holding on their balance sheets. In an industry shaken by trust issues, an increase in in-transparency is not something that would help to rebuild confidence.
Second, if some financial intermediaries continued operating under the mark-to-market rule while others used a different accounting rule, it could create a situation in which those financial intermediaries would appear to be hiding something, creating a two class sector and forcing in the end all financial intermediaries to stick to the mark-to-market rule.
Finally, financial analysts could, certainly would and in fact should (since it is their job) try to second-guess the balance sheets of those financial intermediaries who didn’t operate under the mark-to-market rule. By including this in their assessments of the financial solidity of a company, it would be a de facto continuation of the rule despite its official abolition.
While the suspension or a redefinition of the mark-to-market rule might make sense at a first glance to help increase stability in the financial system, it would be very difficult to implement at this juncture. Moreover, blaming an accounting rule for the ongoing crisis is a little bit like blaming the thermometer for having fever. No accounting rule whatsoever, can obfuscate the fact that bad investment decisions have been made for which a price is paid right now. While accounting might have become less boring, economics continues to be a dismal science.
No comments:
Post a Comment