I think the mark to market accounting standard must be changed.
From Robert McTeer
In 2008, when the subprime mortgages in these pools began defaulting at a higher rate, the market for MBSs dried up. Yet, rigid mark-to-market accounting rules, enforced by regulators, forced the drastic write-down in the value of MBSs, even when investors were both willing and able to hold them until the market improved or to maturity, when the loans would be paid off, if necessary.
However, even though the MBSs have hardly been trading, most of the underlying mortgages are still generating income, making them worth more than their marked down prices. Thus, a cheap way of addressing the financial crisis and saving banks is to suspend these mark-to-market rules. ...
According to Milton Friedman, mark-to-market accounting was responsible for many banks failing during the Great Depression. In fact, President Roosevelt suspended it in 1938. The practice reappeared in the mid-1970s and was formally reintroduced in the early 1990s. ...
The tragedy in marking to market comes not from the write-downs per se, but from the resulting decline - dollar for dollar - in regulatory capital.
As a general accounting rule, investments drop in value when their market price drops below their original purchase price, a situation called impairment. Impairments can be classified as "temporary" or "other than temporary," in which case they must be written off as worthless.
For example, if a bank buys an MBS with 1,000 underlying mortgages and a few of these mortgages become "other than temporarily impaired," the bank must write down the whole bond - not just the impaired mortgages. The write-downs would be much more modest if the same 1,000 mortgages were separated. For example, the Federal Home Loan Bank of Seattle has a portfolio of MBSs that are predicted to only lose $12 million in the long run. However, the MBSs were marked to market because they were classified as "other than temporarily impaired," causing the bank to report a $304 million loss.
Although the original mark down may not be justified, it can lead to a real loss of capital. This loss of capital may lead to higher capital requirements at a time when capital is becoming scarcer. A bank's worsened condition may also require it to pay higher Federal Deposit Insurance Corporation (FDIC) deposit insurance premiums in order to preserve the deposit insurance fund. As this process is multiplied across the banking system, these premiums may be raised across the board.
Consequently, the banks have their capital requirements increased when they can least afford it. The FDIC, after keeping its premiums low during good times, has to raise them during bad times. This is procyclical because it makes an economic downturn worse, and can artificially reinforce an economic boom.
And from Jason Schwarz
On April 2nd, FASB will vote on the proposed alterations to this nightmare mark to market regulation. We have heard rumors of two new proposals. The first will change the requirements for actually taking a writedown and the second will allow companies to determine whether a particular market is active or inactive and they will be able to declare a related security as ‘distressed’. I love these new proposals because they maintain transparency for investors but the new regulation won’t force the bank to raise capital during times of short term overreactions. This solves a big problem for the banks.
The question on investors' minds is how will the new mark to market rules affect the plan of the Treasury, Fed, and FDIC to pump trillions of dollars into purchasing these toxic mortgage securities? Many investors are confused because it appears that all of this money won’t be needed because of the regulatory change. Let me tell you why it is still needed. These toxic assets need a pricing mechanism. Geithner, Bernanke and company have put into place the necessary components to bolster the market for these securities. Banks won’t want to sell them off because of the new mark to market rules but there will still be trillions of dollars of demand for them. Huge demand with no supply is superb news for the banks and for lending. It’s exactly what the government wants. These toxic assets won’t be toxic any longer. Writeups will replace writedowns and bank share prices will return to prior norms. This solves another big problem for the banks.
The government is in the process of eliminating negative balance sheet pressure for the banks and at the same time they are solidifying the pricing mechanism for these toxic securities by maintaining and strengthening the market for them. It is a brilliant plan. It is the solution we have been waiting for and it has created the buy of the year.