Monday, 16 March 2009

Banking crisis solved?

Perhaps this blog should be called eek-o-nomics. The government's disastrous management of the economic disaster remains the biggest political story of our times.

So today I present my solution to the banking crisis:
Lift the requirement for banks to use mark-to-market asset values.

Marking-to-market is an accounting practice that developed on futures trading exchanges in the 1980s. Its aim was to protect market makers from potential defaults by traders. Traders were required to price their asset holdings at the end of each trading day or week at fair current market values. This ensured they didn't exceed their credit margins due to changes in the market or sales value of assets they'd bought.

Mark-to-market gradually spread as an accounting practice to value almost any kind of asset. Its virtue is seen as revealing a true price valuation of assets, rather than historic value, for the benefit of investors, shareholders and anyone rating current value of stock.

The practice is supported by international accounting bodies and applied by regulators such as the FASB in the US and, presumably, the FSA in the UK. But there has been increasing pressure, especially in the US, to lift its requirements.


Because the effect of marking-to-market in this crisis - and a considerable contribution to its cause - is to rate banks' lien over mortgaged property assets as valueless. This is because in the present turmoil there is no active market in the derivatives attached to these mortgage loans. These 'toxic assets' create an enormous balance sheet black hole. Yet, this doesn't reveal underlying asset value. It simply reflects the absence of any price-revealing market at all.

Legislators in the US - not for the first time in this crisis - are lobbying strongly for changes in mark-to-market rules. Federal Bank chairman, Ben Bernanke, is being cornered to respond. But so far his response has been ambiguous.

How about the UK?

The need for change in the UK is perhaps even more urgent. Obama's new reflation package is still stuck in Congress. Here, Brown has committed £585 billions of taxpayer's money (so far) in a bank Asset Protection Scheme with hardly a parliamentary debate.

Lifting mark-to-market rules and repricing banks' property-based assets at their original cost price (less an averaged loss from repayment defaults) would be no less unrealistic than their present unaccountable guesstimate value. It would actually allow a better estimate of where bank finances really stand.

The effect would be to significantly rebuild banks' balance sheets - in appearance anyway - until property prices bottom out and a functioning price market returns, when these assets can deliver back some value.

But perhaps the biggest benefit would be to the operation of banks and the wider economy. With assets restructured to reflect long term regeneration, banks could focus on current profit building, from prudent lending, without fear such profits would instantly disappear into the bottomless hole in their balance sheets.

And if accountants tut-tut at messing with such important rules, perhaps they should look at the government's accounting practices. Since the £585 billion asset protection scheme is named 'contingent liabilities' the Treasury seem set to record the impact on the public finances as zero!

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