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New Mark-to-Market Rules Coming

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Highlights include Citigroup Inc. (C), Bank of America Corp. (BAC), Goldman Sachs (GS) and Morgan Stanley (MS).

The House Financial Services Committee, led by Rep. Paul Kanjorski (D-PA), yesterday successfully browbeat the Financial Accounting Standards Board (FASB) into coming up with modifications of the mark-to-market rules for valuing bank assets. Wall Street, which over the last 10 years has invested over $5 billion in lobbying and campaign contributions, is seeing a nice payoff on their investment. Investors, not so much.

The claim is made that these "toxic" assets are not being truly valued by the market. Why would that be the case? Is this some little obscure asset that nobody has ever heard of? Hardly -- there has been endless talk about them for months, not just in the financial press, but in the general press as well.

Too illiquid? Yeah, it might be hard for your average individual investor to go out and buy the C tranche of the Bear Stearns 2006 pool of first mortgages, or something like that. But why haven't the institutional investors or hedge funds been stepping up to the plate? Why not the fixed income or balanced mutual funds? What is stopping them from buying these supposedly severely undervalued assets?

The people who have been complaining the loudest about mark-to-market accounting are not exactly homeless folks sleeping under bridges. On the contrary, they tend to come from the very wealthiest sliver of society. So if these assets are so cheap, why aren't they buying? At the right price, these assets would get sold.

The problem is that if these assets were sold at the value that any of those claiming they are so cheap would be actually willing to buy them, then banks like Citigroup (C) and Bank of America (BAC) would be insolvent. The same it true for the Investment banks like Goldman Sachs (GS) and Morgan Stanley (MS).

The reason that these markets have dried up is not that there are no buyers. It is that the current holders cannot afford to sell. This is exactly like in the early days of the bursting of the housing bubble. In late 2006 and early 2007, inventories of houses for sale started to build up, and the number of houses sold started to fall sharply, yet the median price of an existing house held up very nicely.

The sellers were trying to hold out for what their house was "really worth" based on what the house down the street sold for six months earlier. So they held out, and now they really can't afford to sell, since to do so would require them to bring there check book to the closing, and they don't have anywhere close to that amount in the account. Does that fact make the house "really worth more"? Of course not!

Thus the idea is to let the banks make up the valuation for these assets. Oh sure -- they will have some fancy black box model showing how much they are "really worth." But anyone with three hours of experience with Excel can make up a spreadsheet that gets the answers they want if they manipulate the numbers and the assumptions that go into the spreadsheet.

There is a term for knowingly publishing financial statements with incorrect values in them, and that term is "securities fraud." The very foundation of capitalism is that the "real value" for something is that which a willing buyer and a willing seller can mutually agree upon. That, folks, is the market price. That is the price at which these securities should be valued.

Supposedly, suspending mark-to-market rules is going to restore confidence in the banking system. This is nonsense. Why would you buy a bank, when it clearly says: "This book value belongs on the fiction shelf"! If a bank is insolvent, it should be taken into receivership. We do it all the time with small banks -- 25 times it happened last year, and so far it has happened 19 times this year.

Yes, it would be more complicated to do so with something the size of Citigroup, but why should there be a different principal involved. There is a difference between the financial institutions and the shareholders of them or their executives. The institutions need to be protected, but their shareholders do not.

Taking over the big banks, cleaning them up and then selling them off as quickly as possible has worked in the past, most notably in Sweden. We should go that route, rather than legitimizing securities fraud.

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