Mark-to-Market: Prospects For Change

There is a lot of buzz about a Congressional hearing on mark-to-market accounting, scheduled for Thursday.  Much of the information is inaccurate or misleading.  Astute investors should understand the purpose of the hearing and what might happen.

Background

When Congress passed the original TARP legislation it required the SEC to study the  possible link between accounting rules and bank failures, reporting within 90 days.  They complied with a series of round tables, public commentary and a report.  This was the last action of the Christopher Cox Chairmanship, with Cox and senior staffers leaving immediately thereafter.  The recommendation was to keep the rule and do minor tweaks.  This is not what Congress expected or hoped for.

The Obama Administration

We have watched closely for a sign of interest from the Obama team concerning this issue, but there has not been much.  Paul Volcker, a senior advisor, favors a change, but there is no sign from anyone else.

Few seem to understand the rules.  Tonight on Kudlow, Steve Forbes, a strong advocate for suspending the mark-to-market rules, stated that the President or the Treasury could change this with a stroke of the pen.  This is not correct.

The accounting rules, as we have frequently written here, are determined by the Financial Accounting Standards Board (FASB), a group that strongly embraces using market prices.  The oversight of FASB is completely under SEC control  The new SEC chair, Mary Schapiro, showed little interest in this subject during confirmation.

This is not something that Treasury can change or the President can change.  The President cannot even fire Schapiro.  He had his chance in making the initial appointment, and it apparently was not an issue on the front burner.

The Hearings

Thursday’s hearings are in front of the House Financial Services Subcommittee on Capital Markets.  What does this really mean?

In the legislative process this does not mean much.  A sub-committee has hearings and perhaps reports a bill to the full committee.  There is then another vote.  The bill needs a “rule” from the House Rules Committee.  Perhaps it gets one and a vote on the House floor.  Then the process is repeated in the Senate.  If a bill is passed in both houses, it goes to a conference committee to reconcile differences.  The final version, if passed, goes to the President for his signature.

We are astounded at the lack of information about basic political processes from everyone covering this story.  It is all the material from an introductory class on American Government.

The Real Message of the Hearings

Most Congressional hearings are not really about passing new legislation, although that is always the stated purpose.  Sometimes it is just intended to send a message.  Readers who are sports fans might remember Congressional interest in the BCS and football playoffs, baseball and steroids, or similar topics.  Congress uses the power to conduct hearings to create a body of information and to focus attention.  By threatening legislation, they move others to change behavior.

In this week’s hearings we expect testimony from accountants who will emphasize the significance of market-based pricing to ensure visibility for investors and to avoid future Enron’s.  This will include official SEC accounting experts.

There will also be some who explain the pro-cyclical nature of the current accounting experiment, conducted in real time.

The issue cuts across partisan lines.  Many Republicans prefer relief on mark-to-market accounting to additional TARP-style investments.  The destruction of regulatory capital via the FAS 157 rule has proceeded far more rapidly than the government can or will provide new investments.  In addition, the system has discouraged any private investors.  Many free-market adherents would prefer some regulatory relief rather than a system where Barney Frank tells  private companies whether they can conduct golf tournaments.  It is a philosophical position.

Democrats are mixed in their viewpoints, which should make entertaining viewing for policy wonks.

Investment Insight

Anyone looking for an investment angle can ask two very simple questions:

1. Are the most important Committee members trying to send a message to the SEC?
2. Is Mary Schapiro listening?

Unless the answer to both questions is “yes”, investors have a long wait for any relief on the FAS 157 rules.

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