Let 'mark-to-market' stay

On Monday, as Treasury Secretary Henry Paulson’s 700 billion bailout plan was rejected by the Congress, former House speaker Newt Gingrich started to preach for suspending an accounting rule as an alternate plan solve the current financial market crisis. Newt made appearances on Fox New, on CNN and published a commentary on the Forbes.com.

“Probably 70% of the real crisis that we face today is caused by mark-to-market accounting in an illiquid market," Newt said, "… If regulators on their own--or Congress, if regulators fail to use their discretion--can fix 70% of the financial crisis by changing the mark-to-market accounting rule, we should change the rule first before attempting to pass another reevaluated bailout package. “

Newt failed to conceptualize the issue and his reasoning is flawed.

Getting rid of ‘Mark-to-Market’ accounting rule will make the symptom a little less severe but will not help with the disease in the long run. We do not have to go back too far in history to find a lesson. In late 1980s, Japanese economy suffered a burst of their financial bubbles. Right before that time, the first 20 largest banks in the world were mostly Japanese. The reason was that those Japanese banks all had loaded with loans of the Japanese real estates which had their prices gone through the sky. When the real estate market crashed, the Japanese banks were on the brinks of collapsing. Fortunately, there were no “mark-to-market” equivalency in Japanese accounting rules and those Japanese banks were allowed to ‘write off’ those bad loans over time with their profits. How long? Till recent years, some the Japanese banks are still working those numbers. In fact, the Japanese economy never fully recovered from that financial crisis. Question to American people is if they want to get rid those bubble quickly and move on or to bear with this pain for the next 20 years.

The fundamental accounting principle is to protect the investors. To that end, it generally requires that the public company take financial gains conservatively and recognize loses aggressively. ‘Mark-to-market’ was created under this spirit. Before this rule was in place, there had been many frauds by company managements who cheated investors by keeping assets on books at their original purchase price. While actually, the market values of those assets had dropped to near nothing. With ‘mark-to-market’, the management will have nowhere to hide. Of course, by then, the account board could not have anticipated ‘mark-to-market’ being applied in such a volatile and yet illiquid market. By then those financial scientists were still holding real world jobs in academics or industries. They had not yet landed on Wall Street virtual economy and had not yet invented those derivatives now known to us as CDO, CDL and SWAPTIONS. Wall Street absorbed those toxic assets out of greed. For years, they booked billions upon billions of profits. Never had anyone cried foul. Today they are losing money and want to suspend the rule to cover up their mistakes. If SEC indeed suspends the 'mark-to-market' rule as Newt has insisted, investors will not know a financially healthy company from a sick one. Worse, those CEOs who made tons of money by participated in those years' near fraudulent operations, will, once again, be able to report 'profits' and take home an obscene sum of financial "rewards." It may be a good idea for the Wall Street, but will it also be a good thing for the Main Street?

http://www.forbes.com/home/2008/09/29/mark-to-market-oped-cx_ng_0929gingrich.html