2 Choices On Mark-to-Market Accounting

In our opinion, requiring financial institutions such as (but not limited to) Citigroup Inc. (C), JPMorgan Chase & Co. (JPM), Bank of America Corp. (BAC), U.S. Bancorp (USB) and Comerica Inc. (CMA) to refinance their portions of the substantial number of Alt-A and Option ARM mortgages that are expected to come due over the next 3-to-5 years would be better than tinkering with FASB rule 157 or mark-to-market accounting.

On Thursday, the U.S. House Financial Services Subcommittee held a hearing on whether or not to modify or make temporary adjustments to mark-to-market accounting (an approach which values financial assets at current market values, even if markets are engulfed in hysteria and diverge from an asset’s obvious intrinsic worth). If such a modification were to become a reality, we would anticipate instantaneously a change in financial institutions’ balance sheets for the better, from at least an accounting standpoint.

However, suspending the mark-to-market accounting would ultimately create a gross aberration of value. The valuations of billions of dollars of assets would result in a financial institution accountants’ modeling or pulling out of thin air what the assets would be worth, by not relying on current market prices. (By the way, these would be the same accountants with the same models that predicted home prices would never fall, subprime was an infallible investment, and 30-to-1 leverage was a good thing).

We submit that there are only 2 choices 1) keep mark-to-market in place or 2) completely repeal mark-to-market.

If we keep mark-to-market in place, then the financial institutions that made the loans would have to refinance the Alt-A and Option ARM mortgages. These reworked loans would carry much higher valuations than letting the homes attached to the mortgages go into foreclosure and be potentially sold for pennies on the dollar (resulting in significant write-downs of the mortgage and the mortgage-backed securities the financial institutions have in their respective investment portfolios).

However, if mark-to-market were to be repealed, then the financial institutions should be required to restate the past 5-10 years to eliminate the effects of mark-to-market accounting, and so the financial statements would be on an “apples-to-apples” basis.

Whether you are for keeping the mark-to-market accounting rule as is, or for repealing it all together, arguably “tinkering” with the rule for a limited period of time would not be an advisable approach. A temporary suspension of the mark-to-market rules would also create significant confusion and artificially enhance the values of the assets in question.

The only logical and clean approach would be for the financial institutions to refinance the millions in Alt-A and Option ARM mortgages that are expected to come due over the next 3-to-5 years and take a realistic write-down, which would in-turn create a better valuation of the assets in question.

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