JEFFREY BROWN: Accounting rules are not normally the stuff of front-page headlines or credited with boosting the stock market. But that’s what happened today, as some otherwise obscure rules were changed.
The rules in question are known as mark-to-market or fair value. Put simply, a bank’s balance sheet is composed of a wide variety of assets, many of which are loans and securities.
Under mark-to-market rules, a financial institution must value those loans and securities at the estimated prices they could fetch on the market currently. But these days, with markets essentially frozen, setting a real-world price for an asset is that much harder. And a debate has grown over whether mark-to- market accounting undervalues assets and unreasonably hurts the balance sheets of financial institutions.
We get some help on understanding all of this from Floyd Norris, chief financial correspondent for the New York Times, and Simon Johnson, professor at the MIT Sloan School of Management and a senior fellow at the Peterson Institute for International Economics.
Floyd Norris, first, tell us a bit more about mark-to-market accounting, what it is, and what it’s intended to do?
FLOYD NORRIS, New York Times: Mark-to-market accounting has been around for a long time. But a couple of years ago, they tweaked the rule to specify that they really had to pay attention to markets.
That greatly offended the banks when the prices began to fall, and they had to take big write-offs. They think that the asset prices now are far lower than they will turn out to be worth when we eventually get out of this economic slump. On the other hand, they’ve not been willing to buy the assets at anything like the prices they think they’re worth.
They went to Congress. They put a lot of pressure on Congress. Congress threatened the Financial Accounting Standards Board, which sets the accounting rules, basically with putting them out of business, and the FASB basically gave in today.
They adopted a rule that pretty much does what the banks want, but they did throw in a sop to angry investors who felt it was going to hurt them to have the banks no longer reveal market values. And they’re requiring more disclosures.
JEFFREY BROWN: All right.
FLOYD NORRIS: How much that will help, we don’t know.
JEFFREY BROWN: All right. I want to come back to some of these issues, but, Simon, back up again a little bit for us, Simon Johnson. The whole idea here, the intention is to come up with the truest sense of the value of an asset?
SIMON JOHNSON, MIT Sloan School of Management: Absolutely. That's what the balance sheets are for; that's what investors are looking for.
And it's interesting. Even the proponents of these changes are claiming there's more information or more accurate information after the rules have been changed. Obviously, that's very controversial.
But the point is to show you, what is a bank really worth? And that's what you need to know, if you're a shareholder or if you're somebody who wants to lend to that bank.
JEFFREY BROWN: So it makes sense -- so if a bank holds an asset, the question is, how much is that asset worth? And the issue is, is it worth what they could get selling it today or when -- a later time when the market presumably comes up? Is that what this is about?
SIMON JOHNSON: That's right. The banks are allowed to hold some of their assets to maturity, and those they don't have to change as the market value changes.
But other parts, they may be trading or they may be holding them and thinking about potentially trading them. And those -- the price on those should reflect the market value. The question is, what's the market value?
And the banks, as Floyd said, have been challenging the legitimacy of the market or saying there is no market for mortgage-backed securities in particular. And, of course, it's the mortgages that got us into this trouble. People are saying, "The market's dried up. There's no meaningful prices. We can't use mark-to-market in the way that it was intended."
JEFFREY BROWN: All right. But for those people not in the financial world, still a little bewildering. These things that we call toxic assets, are they any less toxic because of a change in accounting rules?
SIMON JOHNSON: No, not at all. And that's why the stock market reaction is kind of interesting. There are various stories about why the stock market would like this, but it's also a little bit puzzling.
As Floyd said, there's going to be more disclosure. Maybe it will all be kind of information-neutral in the end. We'll know what's been changed and why.
But it really -- it's a little bit like adding some more lack of -- reducing transparency or reducing the clarity in a market and for a set of securities that were already pretty opaque.
Banks appealed to Congress
JEFFREY BROWN: Well, Floyd Norris, now, you referred to the FASB. Now, that's the Financial Accounting Standards Board. First of all, who are they? And where was the pressure coming from that you were referring to, to make the changes? You talked about banks, and I think you referred to political pressure.
FLOYD NORRIS: Yes. It's a group of five people who were appointed, and they sit in Connecticut, and their job is to write the accounting rules for the United States.
They're all expert accountants. They all know accounting intricacies far better than most accountants. And they tend to work on what is proper accounting, what makes sense to an accountant.
The politicians often don't like the results. In the 1990s, Congress got upset because the Accounting Standards Board wanted to force companies to report the value of the stock options they were giving to executives as an expense. The company's fought it and, once again, the FASB backed down, though it did force a little more disclosure. And it took basically another decade for that accounting rule change to come after the companies that were fighting it had lost a lot of battles and a lot of prestige.
This time, the banks, especially the smaller banks, went to their Congress people and said, "The reason we can't lend is because they say we don't have enough capital. But we would have enough capital if they just would let us value these assets at what we think they're really worth." And that got a really good reception in Congress.
A few weeks ago, there was a hearing of a subcommittee of the House Financial Services Committee where every member there was denouncing Bob Herz, who's chairman of the Accounting Standards Board, and demanding he change the rules. And Herz before that hearing had been talking like he wouldn't make very many changes. And a couple of days after that hearing, they announced plans for these rules, which were substantial changes.
Less pressure on banks
JEFFREY BROWN: Now, Simon, we referred to the stock market going up. The stock market liked this.
SIMON JOHNSON: The stock market loved it. Admittedly, this was a good day for other reasons, and so there was a certain positive spirit around the G-20. But people think this is good for banks and this is good for the economy more broadly. It's not clear why the reaction was so strong, and it's not clear if it's going to last.
JEFFREY BROWN: What's possible reasons...
FLOYD NORRIS: Excuse me. I don't -- excuse me...
JEFFREY BROWN: Go ahead. Go ahead, Floyd.
FLOYD NORRIS: I'm not sure this had a whole lot to do with the stock market today. The big rally started in Asia long before the Accounting Standards Board met. And the fact they were going to pass this today has been known for at least a few days.
A few more details came out today, but the market was soaring before those details came out. These are two things that happened on the same day; I'm not sure they have much more relation than that.
JEFFREY BROWN: OK. Well, take the stock market off the table, Simon. Another thing that was talked about here was the possible impact on the government's plan to deal with bad assets.
SIMON JOHNSON: Right.
JEFFREY BROWN: How do you see it playing, pro or con, there?
SIMON JOHNSON: Well, it certainly -- it seems very unlikely to help the government. Remember, the idea of the government is to try and force banks to sell some of these toxic assets and encourage hedge funds and other investors to buy them at a higher price than they would otherwise. And the government lending, those so-called famous non-recourse loans, cheap loans, are going to help close that gap.
Well, after today, I think the banks are going to feel less pressure to sell. And they may also be able to ignore prices that they see in these auctions when it comes to marking what's on their balance sheets.
So, in general, it's not going to help what I think Secretary Geithner is trying to do with his plan.
Impact on toxic assets plan
JEFFREY BROWN: Floyd Norris, how do you see the pros and cons, the impact on the government plan?
FLOYD NORRIS: Well, it could have a different effect. I'd like to hope it will, but I'm far from sure it will. And that is that, if the Geithner plan works, if we get a real market in these assets, then under this new rule, as well as the old one, the banks will have to say this is a real market and market those values and this rule will become somewhat irrelevant.
If the prices went up enough, the banks would get the values that they claim they're worth. And, you know, we basically have everyone happy, I think, at least for a little while.
Whether it could -- it very well may make the plan harder to pull off, but if the plan is pulled off, that could negate the importance of this.
JEFFREY BROWN: All right, why don't we leave it there? Floyd Norris and Simon Johnson, thanks for helping us understand this.
SIMON JOHNSON: Thank you.