Mark-to-market changes: Don’t count on a solution
Today's Financial News - Posted March 9, 2009
Many investors want to get rid of mark-to-market accounting rules. Sure it will create a one-time trading opportunity. But in the end, it will only make things worse and could cost us all a lot of money.
By Andrew Snyder, TodaysFinancialNews.com
Baltimore – (TFN): If you think last week was a big one for the banking sector, this week could blow your mind. The catalyst will come at 10:00 a.m. this Thursday when a House subcommittee meets to discuss the near-term fate of mark-to-market accounting rules.
If the recent surge in calls for temporarily relaxing the market-regulating rules gains traction, we could easily see triple-digit share price gains at some of the nation’s most prominent banks. After all, without mark-to-market accounting, many banks could re-write their balance sheets. Assets that were once written down to nearly zero could be given just about any valuation.
Unfortunately, that is where the trouble and the opportunity lie.
With current accounting standards, banks must account for their assets, like bundles of mortgages and risky loans, at today’s prices. But nobody really knows what today’s prices are. After all, nobody is buying anything. That means banks have been forced to write down many of their least-liquid assets to nearly zero, the only price they know they could get.
But if the accounting rules are suspended, oh boy, banks could value those same assets at just about any price. Because there is no liquid market, finding a true fair price is nearly impossible. If a bank says its mortgages are worth six trillion dollars that is the price its balance sheet will portray. It will not matter if those same assets are listed as just a million dollars of value today.
Investors want to suspend mark-to-market accounting because it will lift valuations by huge proportions. As soon as the regulation is lifted, corporate accountants can start adding multiple zeros to all sorts of assets. And of course, those zeros would find their way to share prices.
With just one change in regulations, investors would go flooding back into the financial sector and send the equities market surging. It would make Washington look like the savior it has promised to be.
The end of economic trouble?
Of course, the gains would only be temporary. Before too long, the newly created bubble would burst and things would start crashing down once again. Even worse, investors would have no way to tell how accurate the new figures are. Without mark-to-market rules, there is nothing stopping a company from flat-out lying about its valuations. Enron’s books would look like a little, white lie.
Remember, mark-to-market is merely an accounting rule. It simply tells us how to price things on corporate balance sheets. It does absolutely nothing to represent cash flows. If banks are not able to rake in the kind of revenue an investor would expect from the newly created balance sheet figures (which is certainly going to be the case with the huge level of foreclosures and loan defaults), a revision in the law will do no good.
An accountant’s books are supposed to be a window into a company’s true value. If we paint a pretty picture on that window by lifting current accounting regulations, the same ugly scene will lie behind the glass.
If Congress starts to show ambition to change current mark-to-market accounting rules, be ready for a major charge in the equities market. But be ready to sell at the top. The gains will not last long. This is a temporary fix at best.
The only way to get out of this mess is to let the free market do its magic. Washington will keep trying to find an instantaneous solution. But we all know it will never work.
This week’s action may create some trading opportunities, but long-term investors should be wary of making any major moves.
*** March 10, 2009 P.S.: To maximize gains on this volatile scenario, TFN Strategic Trader Andrew Snyder recommended one particular Call option today. There’s some risk in this play, with expiration in just under two weeks, but the potential is huge: “At their current price of $0.50, the breakeven on these options is $18. Shares of the stock are currently trading for $16.10, but traded above $18 as recently as last Thursday. With a little help from a market pop, this company should be above that level again before expiration.”
These options are still priced at $0.50, and Andy sees opportunity in buying up to $0.65. This is a straight-forward options play that anyone with Level 2 privileges can execute. If you feel ready to join our TFN Strategic Traders on this play , please follow this link…
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Next Article: Citi’s memo: Can you believe it?
3 Responses to “Mark-to-market changes: Don’t count on a solution”
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March 9th, 2009 at 11:11 pm
That is what Accounting is, taking stock of the true value of assets. Any change to the Mark to Market will only shortchange the investor.
March 9th, 2009 at 11:37 pm
According to me, Mark-to-Market is very absurd. There should be something in between to valuate an asset. If an asset’s value is not based on its intrinsic value but at the price you can sell, then in this market you can break its value to near zero. It is an opposite of a monopolistic trade. Here there is no protection for the seller. A bad bank plan is the way to go here. It will not only protect the seller, but also start adding value to the asset in the market.
March 10th, 2009 at 4:34 am
The mark-to-market rule works fine, when the markets are working. Unfortunately, it doesn’t work fine, when the markets are not working. This doesn’t mean it needs to be abolished. It means it needs to be fixed, to handle both conditions properly.
One idea I heard some months ago was to calculate asset values on a 3-5 year moving average. This might be a reasonable compromise, since:
1. assets would retain their full value during normal market conditions.
2. asset values would adjust in a more orderly fashion, during poor market conditions.