Sunday, February 08, 2009

Mark to Market Rule

As many followers of ongoing bank fiasco would know, one of the most crucial battles raging is about the ‘mark to market accounting rule’. The issue is how a bank should value its asset – say a loan to a homeowner. If bank says it will be holding the loan till maturity, the current accounting rule says the bank can assume the value of that asset at book value. If the bank is intending to ‘sale’ this loan and hence not going to hold till maturity, it will have to assume the value as what it can get for this loan in the market. So as anyone can expect, when the bank’s asset is a CDO of subprime mortgages, in today’s market the price will be devastatingly low; essentially creating the hole in bank’s balance sheet.

Folks are arguing that this ‘mark to market’ rule should be relaxed. Meaning even if a bank has a CDO or a loan which it does not intend to hold till maturity; folks want to value it at the face value of that loan. This will inflate the asset ledger for a bank helping it in its capital adequacy ratios. Basically, a short cut to what any fair investor would normally expect – today’s real value of an asset. As the rumor started last week that Geithner would indeed relax this rule for banks and Obama Administration would work with Congress to make necessary legislative changes; traders got the spark and the market started to get uplift. If one follows The Street Dot Com web site, JJ Cramer and the company is heavily rooting for such a relaxation.

It is not just a battered trader or a bank on Wall Street who wants this relaxation. European Authorities are on record to opt for such relaxation. A naive reader, like this blogger, would also say if relaxing some accounting rule solves the current mess, let us do it for a while; anything which alleviates the pain of folks.

But one can see how things are complex and clouded in today’s world. Relaxing this rule is not so straight forward and not necessarily a good road to travel. You have no less than Goldman Sach’s CEO - Lloyd Blankfeinarguing in Financial Times that such a relaxation is not the way out of the current mess.

Blankfein talks about the well known GS business practice of valuing all assets at the end of every day based on their market value. In other words, he says that such a ‘mark to market’ process essentially saved Goldman. (For those from India, this can be related to ‘marwari rule’ – earn cash every day and balance book every day.)

By now it is clear to the whole world that Goldman is one of the survivors of this Financial Depression along with JP Morgan and Wells Fargo. It is surely one of the rare breed of banks to be able to overcome the devastation taking place in American Capitalism. So if GS says it is okay to have ‘mark to market’ rule, practically any such relaxation should be out of question.

It looks like our mess is not so simple that by changing some accounting rules, it will be solved. Lloyd Blankfein’s article talks many other avenues to fix what is ailing our markets. May be that is where the salvation is.

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