Special Report

Facile Accounting

It's killing Arianna, but last week's easing of the mark-to-market rule is giving economic recovery a chance.

By 4.7.09

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Liberal gossip monger Arianna Huffington ought to know by now that it is better merely to be thought a fool than to open one's mouth and remove all doubt.

On Sunday's This Week, Huffington provided an ahistorical account of the so-called mark-to-market or "fair value" accounting rule that forces businesses to value their assets at zero or pretty near zero when markets for those assets temporarily disappear. In a major bean-counting breakthrough that boosted bourses, the rule was eased April 2.

This is significant because since the Financial Accounting Standards Board (FASB) modified its accounting fiat known as Rule 157 (a.k.a. FAS 157) last week, banks are no longer being forced to value their assets at current market prices if they believe the market is illiquid and that most recent transactions are being carried out by distressed sellers offering fire sale prices.

Right now left-wingers like the rule because it reinforces their argument that more government intervention in the marketplace is needed. The rule hurts the capitalist villains in their anti-market narrative that holds business and the profit motive responsible for all that is bad in society. It reinforces their cartoonish claim that the actions of evil money lenders -- as opposed to misguided government policy makers -- were primarily responsible for the current recession.

Huffington's know-nothing bloviations about the rule change illuminate this liberal delusion:

This week, we saw so many concessions to the banks. We saw the suspension of mark-to-market, which is absolutely tragic. Japan, by not having mark-to-market, made it much harder for them to recover...so basically now it's become mark-to-fantasy. They can put down any number they want and they are basically perpetuating all these gimmicks that have gotten us where we are. And the government is going along with that because basically [Treasury Secretary] Tim Geithner and [Director of the White House's National Economic Council] Larry Summers and understand that world, this is their world, and this is really the world to which they keep making concessions.

Like other liberals who reflexively cheer whatever hurts the big bad banks, Huffington doesn't seem to understand that easing FAS 157 is not a concession to banks: it's a concession to reality. The mark-to-market rule is the accounting gimmick, one that overstates losses and makes things seem worse during a crisis than they actually are.

The rule is fundamentally unfair to financial institutions and market participants -- especially long-term investors -- and directly contributed to the current economic crisis.

In October, former Federal Deposit Insurance Corp. (FDIC) chairman William Isaac blamed FAS 157 and an overzealous Securities and Exchange Commission for destroying "$500 billion of bank capital by its senseless marking to market of these assets for which there is no marking to market, and that has destroyed $5 trillion of bank lending," he said.

Economists Brian S. Wesbury and Robert Stein wrote much the same thing in Forbes in February:


They insist that in the 1980s and 1990s there were "at least as many, and probably more" nonperforming loans in the nation's banking system as a percentage of the overall economy. The difference was that the mark-to-market rule was not in effect then. Its absence allowed banks the time they needed to deal with their problems.

While this was happening in the Reagan-Bush 41-Clinton years, Wesbury and Stein continued, the federal government slashed marginal tax rates and raised interest rates, which spurred economic growth. "Time and growth allowed those major banking problems to be absorbed, even though roughly 3,000 banks failed, without creating an economic catastrophe," they wrote.

The two economists note that the late great economist Milton Friedman also warned of the dangers of pigheaded accounting rules.

Friedman wrote that mark-to-market accounting was used throughout the Great Depression and contributed to the death of many otherwise viable financial institutions. President Franklin Roosevelt wisely suspended it in 1938. America did without it for nearly 70 years until, like a vampire, it somehow came back to life in 2007 after a series of major accounting-related corporate scandals.

Even in the midst of last year's market meltdown, the obstinate then-Treasury Secretary Henry Paulson refused even to consider suspending mark-to-market to ameliorate the crisis. A few months before the September stock market crash, Paulson said he believed in mark-to-market: "I think it's hard to run a financial institution if you don't have the discipline which requires you to mark securities to market."

It's also hard to run a financial institution when it's being knee-capped by ill-considered, anti-growth accounting rules.

The easing of FAS 157 is no panacea, but it's a step in the right direction. Kicking the nation's lending institutions when they're down will not bring back America's prosperity.

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