(Update 1: adds OTTI discussion) The anti mark-to-market lobby found a new ally Tuesday morning in House Financial Services Committee chairman Barney Frank (D-MA), who told reporters that he supported rolling back so called ‘fair value accounting’ standards in certain instances, to allow banks and other financial institutions to recoup previously-marked losses on their trading books. The controversial accounting standard, most commonly embodied by FAS 157, establishes guidelines for how companies should go about coming up with market, or fair, values. This standard only applies when firms are either required to use market values for a particular instrument — i.e., a bond that is in a trading account — or for which they’ve chosen to use market values. FAS 157 went into effect in November 2007, and critics have charged that it has helped fuel the financial crisis as financial institutions have been forced to write-down the value of some of their assets to market values that some say does not reflect the ‘intrinsic’ value of an asset. Supporters, however, argue that fair value accounting standards force greater transparency and help prevent banks and other financial firms from ‘gaming’ their own trading books. Regardless, so-called ‘mark to market’ losses total well into the hundred of billions of dollars — reversing the accounting standard, and allowing firms to claw back existing marks, would have the immediate effect of generating equity capital for troubled banks and financial institutions. According to MarketWatch, Frank “said he would support a procedure for firms to make the case that they have been forced to take losses on assets that they are holding to maturity.” “They ought to be able to go back and say they took that loss on an asset that is being held to maturity and recoup that loss,” Frank told a banker who asked him about retroactive losses, according to a separate MarketWatch story. Excuse me, but what? An “asset that is being held to maturity” is already usually carried on the books at amortized cost, not market value. Only those securities classified as ‘available for sale’ (AFS) are subject to mark-to-market rules under FAS 157, precisely because they aren’t being held to maturity — and are otherwise available for sale, as the moniker directly implies. Excerpting from Linda Lowell’s most recent analysis of the PPIP, which has relevant insight here for fair value accounting and the AFS bucket:

Right now, according to FDIC call report data for Q4 2009, in aggregate, US commercial banks categorize a bit more than 90 percent of their debt securities as available-for-sale (AFS). In the FDIC’s standard large bank cut of the data (511 institutions with assets greater than $1 billion), 93% of their debt securities are classified as AFS. Quick accounting refresher: AFS securities are measured at fair value. A change in fair value does not affect earnings, but gains or losses over amortized cost are accumulated in a component of equity called Other Comprehensive Income (OCI). This running cumulative total is also referred to as unrealized gains or losses. Unrealized losses reduce equity capital and are taken into account by equity investors, BUT they are not included in calculations of regulatory capital.

It’s possible that Frank was referring instead to impairment rules, or OTTI (other-than-temporary-impairment), rather than the mark-to-market moniker that MarketWatch seems to have somewhat arbitrarily assigned to his comments. In that case, I’d hope that Frank is aware that the FASB has already proposed a set of changes to the treatment of impairment losses, such that only a portion of impairment representing credit losses would be recognized in earnings. (See “FASB Acts!“, Mar. 17). I think what Frank is referring to here is the theory that suggests market (and, perhaps, even impairment) losses on debt securities reflect a so-called liquidity premium, versus a so-called credit risk premium. In other words, Frank is arguing the same old line that says the value of troubled securities has been pushed down below some ‘instrinsic’ value, assumed to be greater than current market prices would imply. But is that really true? As Linda Lowell points out in her commentary, “No one knows the long term value of these troubled toxic legacy assets, because know one knows where the bottom is because no one knows when the housing stabilizes (and this will be a local phenomenon). This is credit risk, just like a weak balance sheet indicates credit risk even though the company is still servicing its debt.” In plain English: altering how you account for the value of an asset doesn’t make a homeowner any more or less likely to pay their mortgage. Write to Paul Jackson at [email protected].