I wonder how many people realize that that FDR got rid of mark-to-market accounting in 1938 after it virtually destroyed the banking sector. According to Brian Wesbury and Robert Stein mark-to-market accounting was the law of the land for most of the Great Depression until it was outlawed by FDR in 1938. Wesbury and Stein report that the rational for mark-to-market accounting in the 1930s seems similar to today’s argument for the rule; the need for greater price transparency based upon the efficient markets hypothesis in the banking sector. FDR rejected the arguments of the efficient markets crowd because he thought that mark-to-market accounting contributed to the Great Depression. For approximately 70 years after FDR’s decision banks operated without mark-to-market accounting and the economy didn’t have the threat of another depression. Years later Milton Friedman wrote that mark-to-market accounting was responsible for the avoidable failure of many banks in the 1930s. Maybe it is just coincidence but immediately after mark-to-market accounting was restored in 2007 the banking sector started into a death spiral. Unfortunately, even thought history seems to be repeating itself few people are trying to learn from the past. Evenso, today’s Congressional hearings on mark-to-market accounting are hopefully the first step towards stopping this terrible man made economic disaster.
From the Wesbury and Stein article:
….The history seems clear. Mark-to-market accounting existed in the Great Depression…Franklin Roosevelt suspended it in 1938, and between then and 2007 there were no panics or depressions. But when FASB 157, a statement from the Federal Accounting Standards Board, went into effect in 2007, reintroducing mark-to-market accounting, look what happened.
Two things are absolutely essential when fixing financial market problems: time and growth. Time to work things out and growth to make working those things out easier. Mark-to-market accounting takes both of these away.
Because these accounting rules force banks to write off losses before they even happen, we lose time. This happens because markets are forward looking. For example, the price of many securitized mortgage pools is well below their value, based on cash flows. In other words, the market is pricing in more losses than have actually, or may ever, occur. The accounting rules force banks to take artificial hits to capital without reference to the actual performance of loans.
And this affects growth. By wiping out capital, so-called “fair value” accounting rules undermine the banking system, increase the odds of asset fire sales and make markets even less liquid. As this happened in 2008, investment banks failed, and the government proposed bailouts. This drove prices down even further, which hurt the economy. And now as growth suffers, bad loans multiply. It’s a vicious downward spiral…
…In the 1980s and 1990s, there were at least as many, and probably more, bad loans in the banking system as a share of the economy. The difference was that there was no mark-to-market accounting. This gave banks time to work through the problems. At the same time, the U.S. cut marginal tax rates and raised interest rates, which helped lift economic growth. Time and growth allowed those major banking problems to be absorbed, even though roughly 3,000 banks failed, without creating an economic catastrophe…
…In the 1930s, because mark-to-market accounting existed, we limited the amount of time available to fix problems…
…Anyone worried about repeating the errors of….the U.S. in the 1930s should focus on the policies that impeded recovery. Suspending mark-to-market accounting is a cost-free way to buy time. It does not allow banks to sweep bad loans under the rug. Bad loans are still bad loans, and banks cannot hide from them. Not suspending it, while at the same time interfering in the economy with massive stimulus and bank nationalization, is a recipe to undermine both time and growth and therefore hurt the economy even more.
The mark-to-market problem is particularly baffling to me. I don’t understand why the U.S. has to keep on repeating the mistakes of our fathers and grandfathers. Is it hubris? Do current financial leaders and policy makers believe that they are smarter than past generations and don’t need to learn from the past?
The list of reasons why mark-to-market accounting is a bad idea and should be eliminated is really long. But the biggest reason is that it is blamed for killing banks and helping put the U.S. into a deep depression. We shouldn’t be testing fate to see if the blame is misplaced or not. Instead, mark-to-market accounting should be re-repealed and FDR’s 1938 decision should be reinstated.
Today the House Financial Services Committee held hearings on mark-to-market accounting and FASB announced that they are going to rework the rules. Hopefully we will follow FDR’s example and this terrible accounting rule will be rejected as a financial boogeyman that has come back from the dead to terrorize us.
rob
Mark, Great post. Many of us have been arguing, for over a year, for some version of hold to maturity valuation or otherwise, but this post really puts the issue in historical context and illustrates its toxicity.
Rob
Po
I agree a lot of what your saying, but mark-to-market accounting is a international trend currently. As more countries are adopting the IFRS, the FASB committee may have felt pressure to alter its policies in order “catch up” with the international standards. Unless nations around the world stop adopting IFRS it is unlikely that the US would sustain its GAAP; doing so would result in many problem, for example: comparability etc.
Again i do agree mark-to-market may not be the way to go. As of currently, mark-to-market has only exacerbated the situation.
javier g mora
The road to recovery will be via restored consumer confidence in the economy. Immediate enforcement of existing regulations and new rules arresting the naked shorting of all financial instruments will have an impact. Stock and bond market prices do matter. Let’s transfer the fear from the average citizen to the speculators and profiteers that put us in this position. Federal regulators could at least start with the following:
- reinstate short uptick rule
– prohibit naked shorting of all financial instruments
– finally regulate CDS trading
– published the list of hedge funds that are SHORT (just like the SEC requires LONG investors to disclose their positions)
– investigate rumor mongering on CNBC, WSJ and other news media
– announce it will investigate and confiscate illegal profits gained from manipulation of financial markets and news media
– announce a review of the FAS 157 mark to market accounting rules
Thank you,
Tom
Mark,
Sorry to inform you but mark to market has absolutely nothing to do with bank failures or the economic crisis that we are in. The “cause and effect” analysis that you have applied in your article “Mark-To-Market Accounting – The Boogeyman Of The 1930s Is Back” is misleading at best.
The fact of the matter is that the federal reserve board and fractional reserve lending are the cause of all asset bubbles and their eventual destruction. The fact that you blame a perfectly good accounting rule indicates to me that either you and/or your firm hold assets whose values are being destroyed by market forces and stand to benefit from a m-t-m rule change.
Free markets must be allowed to adjust the risk reward relationship to a proper balance. If you think that the market has it wrong and that everything is underpriced then feel free to buy up these mispriced assets and suffer the consequences. A lack of transparency won’t solve anything because shit stinks regardless of how it is packaged.
Of course you already know this but strive to remove transparency which is the precursor to bilking investors and the taxpayer.
You are a wolf in sheep camouflage.
Dean Petkanas
Dear Mark:
SFAS No. 157 defines “fair value” as follows: Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
IFRS generally defines fair value as “the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction” (withsome slight variations in wording in different standards).
These differences were covered in the SEC review of Mark to Market Accounting.
I believe a move to IASB standards will help in the long run as it liberalizes but doesn’t eliminate the need to provide for more transparency on the types of complex investments being carried.
Obviously an electronic exchange would be a major boost to the application of marks on past/present/future entry and exit pricing and the ISE and other clearing agencies will be big players in this regard.
As per the article, it spends a lot of time discussing FDRs assessment of M2M and the Great Depression. Bernanke, a noted historian on this era, does not concur on the elimination of M2M accounting, but rather, he suggests improvements to the model so as to not forgo transparency.
Most importantly, banks got in trouble in spite of M2M accounting and took on inordinate leverage on orders of magnitude that would create an immediate margin call in any environment (stocks, bonds, commodities, etc.). Calling M2M the time bandit and culprit is like saying, without the standard, the problem could conceivably gotten infinitely worse. M2M accounting and the FVO (despite the timing in 2007), caused banks to be “accountable” to their risk measurements, clearly out of whack in any standard, notwithstanding BASEL II.
Kindest Regards,
The Mad Greek
David
It seems that my home is being marked to the current depressed market while trying to refinance away from a 5/1 ARM. Banks are wanting to run a double standard. Screw the consumer and inflate assets to leverage more. Mark to market isn’t the problem, it is the banks under reserving.
AURELIALucas31
According to my own analysis, billions of persons in the world get the credit loans at different creditors. Thence, there is good possibilities to find a collateral loan in all countries.