SEC report on mark-to-market

As noted in an earlier posting, the financial emergency legislation (notice I am trying very hard not to use the words "bailout') passed by Congress late last year required the SEC to report back on its mark-to-market account rules. Last Tuesday (right before the New Year's Eve shut down), the SEC delivered its report. Contrary to what some may have wanted, the report does not call for a suspension of mark-to-market (also know as fair value accounting). The report goes on to state, "Fair value and mark-to-market accounting has been in place for years and abruptly removing it would erode investor confidence in financial statements." Instead, the report calls for a number of specific improvements to how mark-to-market rules and calculations operate.

It also clear does not put the blame for the problem on these accounting rules. The report gives a succinct statement of the cause:

Rather than a crisis precipitated by fair value accounting, the crisis was a “run on the bank” at certain institutions, manifesting itself in counterparties reducing or eliminating the various credit and other risk exposures they had to each firm. This was, in part, the result of the massive de-leveraging of balance sheets by market participants and reduced appetite for risk as margin calls increased, putting enormous pressure on asset prices and creating a “self-reinforcing downward spiral of higher haircuts, forced sales, lower prices, higher volatility, and still lower prices.” The trust and confidence that counterparties require in one another in order to lend, trade, or engage in similar risk-based transactions evaporated to varying degrees for each firm very quickly. What would have been more than sufficient in previous stressful periods was insufficient in more extreme times.

The SEC report will probably be attacked by those who are convinced that mark-to-market is evil. The report, however, appears to me to be a thoughtful analysis with useful recommendations which Congress, the SEC and FASB should weigh carefully. Whether that rational approach is followed or the political approach (similar to what happened in the EU) remains to be seen.