Tuesday, March 10, 2009

Bernanke may not want MTM rules to be “suspended,” rather he would like to see them “improved.”

From Operation ARMageddon:

"Does Bernanke Want to Dump Mark-to-Market Rules? March 10, 2009 – 3:21 pm

by Rolfe Winkler, CFA

Reader H forwarded an interesting article from CNN Money. It quoted Fed Chairman Bernanke saying he wouldn’t support a suspension of mark-to-market (also called “fair value”) accounting:

“I would not support any suspension of mark-to-market,” the Fed chief told the Council on Foreign Relations after delivering a speech on financial regulation.

Though it makes his task of rescuing banks much harder, even Treasury Secretary Geithner has said he supports MTM as a means to improve the transparency of balance sheets. But a closer look at Bernanke’s prepared remarks suggests the Fed Chairman has a more open mind. (emphasis mine)

It seems obvious that regulatory and supervisory policies should not themselves put unjustified pressure on financial institutions or inappropriately inhibit lending during economic downturns. However, there is some evidence that capital standards, accounting rules, and other regulations have made the financial sector excessively procyclical–that is, they lead financial institutions to ease credit in booms and tighten credit in downturns more than is justified by changes in the creditworthiness of borrowers, thereby intensifying cyclical changes.

Rolfe here. Excessively pro-cyclical is exactly how opponents describe mark-to-market accounting. If credit structures are still performing, why should banks be forced to mark them down? Banks forced to take writedowns have less capacity to lend. Since lending is a primary source of cash to buy assets, reducing lending reduces the bid for those assets. Asset values fall, which results in less lending and even lower asset prices. It’s a self-reinforcing cycle. Hence “procyclical.”

The same thing helped inflate the bubble by encouraging more lending on the way up. As I noted yesterday: “As asset values increased, so did the value of collateral to support new lending. More lending inflated asset prices, increasing the value of collateral yet again, encouraging still more lending. Since house prices never fall, everyone imagined this cycle could continue ad infinitum. And even if they didn’t think so, no one was going to get in the way. Too much money was being made.”

In his recent book, George Cooper quoted a fascinating 19th Century paper by J.C. Maxwell, which spoke of the need for counter-cyclical “governors” to control the oscillations of mechanical systems. When a machine gets going too fast, it’s necessary to ease on the brake. But not so hard that the system comes to a crashing halt. When it slows down, it’s necessary to hit the gas. But not so much that the system speeds up out of control. Good central bankers should operate the same way. It’s their job “to take away the punch bowl just as the party gets going.” Unfortunately, they utterly failed to do so.

Bernanke may not want MTM rules to be “suspended,” rather he would like to see them “improved.” Hmmmm. Could this be a reason financials jumped so much today? Back to Bernanke’s speech:

The ongoing move by those who set accounting standards toward requirements for improved disclosure and greater transparency is a positive development that deserves full support. However, determining appropriate valuation methods for illiquid or idiosyncratic assets can be very difficult, to put it mildly. Similarly, there is considerable uncertainty regarding the appropriate levels of loan loss reserves over the cycle. As a result, further review of accounting standards governing valuation and loss provisioning would be useful, and might result in modifications to the accounting rules that reduce their procyclical effects without compromising the goals of disclosure and transparency.

Indeed, work is underway on these issues through the Financial Stability Forum, and the results of that work may prove useful for U.S. policymakers.

Bernanke has consistently said he doesn’t support suspension of mark-to-market because he doesn’t want to increase the opacity of balance sheets. But this speech suggests otherwise. It’s interesting that he mentions the Financial Stability Forum. They’ve said quite clearly that they want to dump MTM…

Personally, I’m still not sure on this issue, though I lean toward supporting MTM.

On the one hand, I understand Bernanke’s point about the importance of counter-cyclical governors to help systems oscillate within an acceptable range. On the other hand, our system moved so far beyond an acceptable range that we may need to bring the whole thing to a halt in order to repair the damange.

If anything, it’s far more imperative now that we reduce lending. As the equity value of our economy falls our collective leverage ratio is actually going higher. Piling on more debt is a terrible idea. By hammering banks’ capital reserves, MTM accounting is forcing severe cuts in lending. That is very painful for the economy, but it is exactly the medicine we need.

I firmly believe that lower asset prices are the only way we can rebuild a solid economic foundation. Bankers are invested in propping up asset values by whatever means necessary in order to protect their balance sheets and their bonuses. MTM accounting is one of the few weapons we have against them.

BUT. To the degree someone can prove that banks are being forced to mark down assets unnecessarily, I would be open to reversing my position here. I just wonder….are there securities still classified as “performing” that the market knows are likely to default before maturity??? If so, then it’s helpful to give the market the power to call bullshit. Would love to hear readers’ thoughts on this.


Speaking of “governors,” the middle of the CNN article notes that the uptick rule might be coming back. The rule prevents short sellers from selling at stock prices lower than the previous trade. This keeps shorts from piling on as stocks fall. It’s a great example of counter-cyclical governor…a far less draconian measure than banning shorting altogether."


  1. Your comment is awaiting moderation.

    As near as I can tell, and someone can correct me if I’m wrong, the point of raising capital standards when a financial institution is downgraded is to keep people from pulling money out of that institution, which they might do if they see that the institution is bleeding capital. Investors need to be shown that their institution is solvent. If you lower those requirements, you will need a government guarantee on those institutions, at least enough to forestall people pulling their money out if they can.

    I agree that we should take a value investing view of the appreciation of assets, but this idea seems a bad deal for the taxpayers, at the very least. The answer is for businesses to build a war chest going up, in order to see them through the going down, or some variation thereof.

    By Don the libertarian Democrat on Mar 10, 2009

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