MTM Relaxation Makes Market Sense
Regulation: With the stroke of a pen, the Financial Accounting Standards Board has eased one of the most onerous burdens on the U.S. banking system. In case you didn't notice, it sent stocks flying.
We've felt for a long time that the standard of "mark-to-market" accounting made little sense for American banks. Apparently, markets feel that way too — after FASB announced it would be repealed, stocks soared Thursday.
The so-called FAS 157 rule, which the public took little notice of, was imposed on the banks in 2007. It forced them to take what are long-term assets and mark them down as if they were short-term ones, based on current market conditions.
It might be coincidental, but this was about the same time that banks and other financial firms began suffering problems that have since left the world economy gasping for air.
In a time when markets around the world have been battered by the fiscal crisis, mark-to-market has made things worse. It has severely damaged banks' balance sheets, forcing them to shrink capital and rein in lending.
For capital adequacy purposes, bank assets have had to be marked down to market value even if loans are being paid on time.
This is an inversion of long-standing banking practice. As economists Brian Wesbury and Bob Stein of First Advisors recently wrote, "The accounting rules force banks to take artificial hits to capital without reference to the actual performance of loans."
Bingo. From the late 1930s to 2007, the U.S. banking system was reasonably stable, with a few exceptions. One big reason for this is the absence of mark-to-market.
The change of heart from FASB on mark-to-market was largely due to Congress. We're happy to report that bipartisan pressure undid the bad rule — a rare thing these days.
Mark-to-market rules, while well intended, have historically been a problem. During the Depression, Nobel-winning economist Milton Friedman noted, mark-to-market rules caused many banks to fail. That's why FDR repealed them in 1938. Those rules had remained dead until two years ago, when they were reimposed as part of a frenzy of ill-considered financial reregulation.
While we applaud Congress, Democrats and Republicans alike, for undoing this, there's still more to be done.
One important move would be to loosen the Sarbanes-Oxley rules that have burdened so many businesses with extraordinarily costly compliance requirements in the interest of "transparency."
In fact, SarbOx has hampered U.S. companies' competitiveness and sent companies seeking to raise capital overseas to float their shares on stock exchanges where the rules are far less strict.
In 2007, when FAS 157 was first passed, one economist estimated it would shrink bank capital by at least $100 billion. Add to that the estimated $35 billion cost of SarbOx, and you have a pretty big regulatory hit to companies' balance sheets in just the last two years — and an even bigger hit to the economy, since corporate and bank capital is leveraged many times when it comes to investments.
We're glad to see some sensible deregulation when the economy needs it most. We hope this is just a start.