On the eve of this process commencing FASB issued new guidance defining fair value accounting (FASB 157), also known as mark to market. This action required market data to be used instead of internal models, and this suddenly created an acceleration of write-downs. This effect resulted from the valuing of risky mortgage assets during a time when the market and credit had seized up. Many of the assets continued to cash flow, but consideration had to be given to what the assets would sell for in the current market, one that was severely distressed resulting in a few fire sales that established the dismal market values thus creating huge losses in bank earnings. The debate concerning this ruling has been ongoing and there are strong points in favor of both sides, but the necessity and effectiveness of this directive needs to be evaluated further.

The ruling was recently relaxed after more than a year of heavy losses in the banking system that has resulted in the need to raise capital during these times of turmoil and consequently leading to the involvement of the Government. FASB changed the guidance to allow the banks to value these assets considering an “orderly” transaction during periods when the market is lacking. This made it possible for the assets to be evaluated based on their cash flows instead of forcing the values to be determined by a distressed market. This should have the effect of relieving some of the pressure of taking drastic write-downs thereby allowing banks to work through the assets with the benefit of time. Each of these assets will still have their true values realized as they continue to perform as intended or move to a loss for nonperformance, and this will happen despite the elimination of a rule that mandated the recognition of created losses based on a nonexistent market.

The Government’s response to this crisis initially began with making equity investments in troubled banks followed by the healthy banks to ensure acceptability and the mitigation of any attached stigma for participating. Regardless of such, the banks continued to take massive losses, so the Government is subsequently responding with their latest plan known as the public-private partnership to buy toxic assets from the banks. This entails a combination of equity investment from both private investors and the Treasury along with debt provided by the Treasury to purchase the assets. However, this plan may be quickly abandoned as the anxiety should start alleviating with the changed accounting guidance thereby allowing the banks to work through the assets more efficiently with adequate time.

There have been recent stories being circulated that the accounting change might undermine the planned public-private partnership. Could we possibly be so fortunate, it seems this would be a preferred outcome. Having the Government involved will only bring ineptness and inefficiency into the process, and it introduces too many unknowns that could render the plan ineffective anyway. Unknowns such as will the banks participate, how will the pricing be determined, will investors trust the Government to not dictate or attempt control after investments have been made? Also, interest will fade quickly for investors if it is thought the government might malign them or seize their profits in the future if success is attained. Changing the accounting rule should prove to be much more efficient by letting the banks work through the assets carefully and not requiring any taxpayer money to accomplish it. Considering the rule became effective only about sixteen months ago and we did okay for the previous seventy years without a similar rule. Why would anyone argue that a retraction is unreasonable considering that it will calm the markets while the debate continues on how to best handle this in the future?