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MAKING CENTS OUT OF THE NEWS
Blog #12
(March 18th, 2009)
MARK TO THE MARKET IS DEAD! LONG LIVE THE UPTICK!
By Tom McAllister, CFP™
The stock market rallied last week, and, of course, there's no end to the punditry as to the "why" of it all. One reason, I believe, is that a "technical bounce" ensued following the 12-year low hit at week's beginning. Perhaps more fundamental is Wall Street's increased expectation of help on two issues: mark-to-market accounting and the uptick rule. (Regular readers will recall Steve Forbes and I each calling for getting rid of the former and reinstating the latter.)
On Thursday, March 12, the House Financial Services Committee held a hearing on mark-to-the-market, during which Robert Herz, chairman of the Financial Accounting Standards Board (FASB), agreed to provide more detailed guidelines on this controversial accounting practice, and to do so within three weeks. The FASB is a quasi-independent non-profit group which develops mandatory accounting standards for auditors, which are universally followed by U.S. accountants.
In one of last year's blog posts, "Rules Gone Wrong", I explained that rules launched in 2008 required banks, on their quarterly statements, to show all their assets, including long term holdings, such as real estate, at current market value. That means that even long term home mortgages on which payments are current must be priced quarterly (as if the homes were being sold right now). Of course these assets were never meant to be priced quarterly, and with the drop in home prices, the mortgages show up as losses on banks' income statements, when in fact no real losses have occurred. Both Steve Forbes and I have been advocates of at least temporarily suspending these mark-to-market rules. The idea would be to give banks a "chance to breathe" and to sell "toxic assets" in a less pressurized environment, at something other than rock-bottom prices.
Happily, it now appears that the FASB is going to move even further in the right direction. FASB is talking about setting "discounted cash flow” accounting standards for mortgages and mortgage securities, since no public market now exists to trade such instruments. Such a change, retroactive to Jan. 1, 2009, would take a huge burden off commercial banks, investment banks, broker dealer firms and others active in this market. Such a sensible accounting method would assign reasonable and realistic value to mortgages held by these institutions on their balance sheets, while at the same time cleaning off the heavy mark-to-market losses on banks' income statements. Not a moment too soon, in my opinion, some "relaxation" of the accounting rule seems likely. When it comes to mark-to-the-market accounting for banks, I wish it a speedy demise!
Prospects are improving for the correction of a second mistake, this one made by the SEC in rescinding the "uptick rule". The original rule prohibited the "shorting" of a stock unless it was "up" from the last previous trade at a different price. Most traders believe benefits from reinstating the uptick rule will be largely psychological, but improved investor sentiment would be reason enough for the change. Without the uptick rule in place, it is too easy for hedge funds and other traders to “gang up” on certain stocks and mercilessly drive them down by repeated short selling. (That is exactly what happened in the 1930s, and what led to the uptick rule in the first place!). This rule should be reinstituted immediately, and maintained as a regular safeguard of stock market stability.
I sense a glimmer of common sense on the horizon…
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