Financial Crisis, EESA and Mark-to-Market Accounting


We are trying to understand why large numbers of Republican and Democratic Members of Congress voted against the Emergency Economic Stabilization Act (EESA) on Monday. 

Tuesday on Good Morning America, Chris Cuomo interviewed U.S. Congress Members Marcy Kaptur (D-OH) and Marilyn Musgrave (R-CO).  Both these ladies said that, although they acknowledged the need for federal government action to address the financial crisis, they did not want to be rushed into voting for a bad bill.  They said they are participating in a study group investigating the best way to proceed, and they promised congressional action in coming weeks. 

Asked for specific proposals, both said they wanted a revised bill to address the housing market crisis, and Ms Kaptur said the SEC should ease up on Mark-to-Market accounting rules.  However, the EESA already addressed these concerns.

To address the housing market crisis, EESA “requires the Treasury to modify troubled loans – many the results of predatory lending practices – wherever possible to help American families keep their homes. It also directs other federal agencies to modify loans that they own or control. Finally, it improves the HOPE for Homeowners program by expanding eligibility and increasing the tools available to the Department of Housing and Urban Development to help more families keep their homes.”

Many of the mortgage-backed securities that have been clogging the books of financial institutions for the past year are considered illiquid.  However, several months before it sold itself to Bank of America, Merrill Lynch held a fire sale of similar securities, selling a large amount of mortgage-backed securities at an average price of about 22 cents on the dollar.  (More specifically, at the end of July 2008, Lone Star Funds, a Dallas-based distressed-debt investment firm, bought asset-backed securities with a nominal value of $30.6 billion for $6.7 billion. )

This sale set an unfortunate precedent for accountants who demanded that other financial institutions mark down similar mortgage-backed securities under Mark-to-Market accounting rules. Bankers have been complaining bitterly that they have been forced to mark assets to an unrealistically low market value.  The mark down of mortgage-backed securities has forced highly-leveraged financial institutions to seek new capital or sell liquid assets to bring their leverage down.  Those banks that were unable to raise sufficient cash have found their equity wiped out, and have been forced to merge with a stronger company or file for bankruptcy.

Those favoring a suspension of the Mark-to-Market accounting rule should be supporting the EESA.  Sec. 132 of the act authorizes the Securities and Exchange Commission (SEC) to suspend Mark-to-Market accounting rules “with respect to any class or category of transaction if the Commission determines that is necessary or appropriate in the public interest and is consistent with the protection of investors.”  Sec. 133 ordered the SEC to “conduct a study on mark-to-market accounting standards as provided in” FASB 157, “as such standards are applicable to financial institutions, including depository institutions.”

The defeated bill specifies the following questions to be answered by the study:

  1. the effects of such accounting standards on a financial institution’s balance sheet;
  2. the impacts of such accounting on bank failures in 2008;
  3. the impact of such standards on the quality of financial information available to investors;
  4. the process used by the Financial Accounting Standards Board in developing accounting standards;
  5. the advisability and feasibility of modifications to such standards; and
  6. alternative accounting standards to those provided in such Statement Number 157..

What is the specific problem that these Members of Congress want with respect to Mark-to-Market accounting rules?  Did they need more time to read the bill before the vote?  (I must admit I did not read this section of the bill before the vote, as the PDF draft was only available late Sunday afternoon and the vote started at 1:30 PM Monday.)  Did they want Mark-to-Market accounting rules suspended while the 90-day SEC study was conducted?  It would seem that Sec. 132 could be invoked during that 90-day period.  Did the Members feel that suspending Mark-to-Market was a substitute to the Treasury purchase of illiquid securities?  The NO votes of these Members remain a mystery, which only they may or may not understand.


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3 Responses to “Financial Crisis, EESA and Mark-to-Market Accounting”

  1. Jason Says:

    The HOPE for Homeowners Act needs to pay less than 36.5 % of the face value of the subprime mortgage back securities. If more is paid the government loses money in the long run and owners of the securities profit now.

  2. Ben Says:

    Just a helpful little tidbit here: The proposed EESA doesn’t cover homeowners facing foreclosures, leaving them out to dry. What if that was you? Rep. Dennis Kucinich addressed this issue in a speech a week or two ago by giving a specific example: 90-year-old Addie Polk, who shot herself in the chest after living in her house for 40 years on La Croix Ave. in Akron, Ohio, after Fannie May foreclosed on her home. Think about people like that. HELP them.

  3. Bur Says:

    Here is a comment that my friend John Wirt sent via email:

    What is the alternative to mark to market accounting? The bank or other
    holder of a security gets to decide what the security is worth.

    In the current environment, one can see why the Wall Streeters
    (Republicans and other free market ideologues) rail against the “mark to
    market” accounting rules imposed on them by FASB 157. They prefer to set
    their own valuations of securities. Like Enron did…..

    But, why in the long run would anyone trust an evaluation decided upon
    solely by a bank or other financial institution? It is in the interest
    of the bank to decide upon a high valuation, isn’t it? Especially, when
    the time to maturity of the asset is long.

    I suppose the market imperfection is that mark to market accounting does
    not necessarily fairly account for the _long term_ probable valuation of
    a security when the psychology of the market is depressed. In depressed
    environment, the market may evaluate many or nearly all assets below
    what their long term (even two years from now) evaluations will be.
    Thus, banks and other holders of securities are forced to “mark them
    down” below their probable return on investment in a longer term, which
    increases margin calls, which results in further depression of market
    psychology, which further depresses mark to market valuations, which
    causes banks and other holders of securities to go under, etc…..

    Oops, another imperfection in free markets. They are vulnerable to
    certain psychological imperfections of human beings as evaluators of the
    monetary value of investments.

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