Fantasy Accounting Extended Another Year

In October of 2008, the Emergency Economic Stabilization Act of 2008 was signed into law. Within this Act was the suspension of mark-to-market accounting by the Financial Accounting Standards Board.

With this rule change, banks would no longer have to write down their assets if another bank sold similar assets at a lower price. A bank could represent a pool of loans on their books at full-value, even though it might only be worth half.

This rule change brought an end to the daily news reports of more bank write-downs (remember those?). It’s not that the assets weren’t worth less, it’s that FASB allowed the banks to pretend they weren’t.

Mark-to-market became mark-to-fantasy.

The largest impact of these new rules has been in housing…where banks no longer have as much financial incentive to foreclose. It has become more profitable for banks to not foreclose on a property because that foreclosure would force them to recognize an actual loss. A book-loss of $200,000, levered 30-1, is $6,000,000 worth of new loans that the bank cannot make. This is the real reason why banks aren’t foreclosing on as many homes.

Mark-to-market accounting was originally set to be re-implemented at the beginning of the year. If it happens, banks would need to take incredible write-downs, raise more money, and immediately become insolvent again.

Necessarily, fantasy lives on.

The Hill reports Accounting rule impact delayed

The Federal Deposit Insurance Corporation (FDIC) said this week that banks would have up to one year to implement new capital requirements resulting from the accounting rule change.

The move is only a partial victory for banks and other financial interests that have sought to delay the regulatory impact for up to several years.

At issue is a rule banning financial entities that banks used to shift risk away from their bottom lines. The special financial vehicles were off-balance-sheet and helped fuel the boom in securities based on residential, student, commercial and other types of loans.

As the housing market foundered under the weight of bad loans, those securities became troubled assets. Banks benefited before the crisis by not having to maintain more capital to offset the risk.

Private estimates have suggested that as much as $1 trillion in assets would need to be moved onto bank balance sheets, requiring banks to raise tens of billions of dollars in new capital.