This is just another really bad component of the legislation that seems to be on the table, we'll have to see the Senate version today.
Mark-to-market accounting.
Unless you work in the world of finance or accounting, this one is probably something that you've never heard of, let alone consider the implications. This post at the Big Picture sums it up pretty well, but the idea is that you need to have an accurate measure of the value of a firm's (including bank's assets. Without that type of accounting, investors and banks will tend to do what they are doing now - refusing to lend or invest. No one knows what the banks' balance sheets really look like because they have not been properly accounting for the MBSs and other assorted risky assets (I will try to get back to explaining the rest (CDOs, CDO-squared, CDSs, etc.) at some point this week.)
Anyway, the plan that went down the other day would have suspended FASB (Financial Accounting Standards Board - they set the rules that accountants in the US need to follow) rule 157. This is the rule that states that these assets need to be marked-to-market. Without that rule, banks are free to mark-to-model and that means we don't know what the assets are truly worth.
This is yet another crucial piece of a bad bill. If these banks are allowed to keep bad assets on the books at whatever value they decide, then investors and other banks will not be willing to invest (the banks need capital - a great solution to this problem would entail lot's of investors stepping in to shore up their balance sheets) and/or lend. That is the reason why we have a credit crunch.
This reminds me of the time that a friend decided to buy tickets to a Patriots playoff game back in the 90s - through a broker - at the time the $200 a ticket (cheap seats) was a pretty steep price. He didn't buy because he was a huge Pats fan, he was speculating. I offered to go to Foxboro with him to help him try to unload the tickets (theoretically for a profit) and bail him out on one ticket for $100 if we couldn't sell them. The market was flooded with scalpers and he was lucky to sell 2 of the 4 for a loss (maybe $150 apiece, can't recall exactly). The point here is that the market decides what the tickets are worth, not you or your friend or me. In his mind those tickets were "worth" at least $200 - that's what's on his balance sheet.
Pretending that they are valued at that price would allow him to borrow more money against those assets (this is a stretch, I'm just trying to tie it back into the current situation) and invest in other assets (MBSs, risky loans, credit card debt, foreign currencies). A better example might be someone that bought a house in the past few years, saw the market prices rising in their neighborhood and took out a line of credit (HELOC) on the house. They booked the value of the house in their mind at that inflated market value. As prices fall, they should mentally write-down the value of their primary asset (the house), but most people cannot do that psychologically. Instead they just think the prices will come back to where they "should" be.
The big difference being argued here is that the banks (amongst others) are suggesting that these assets will be worth more than the market price at some point in the future. This is in fact, the core of Paulson and Bernanke's justification for their approach to solving the problem. Surely all of the MBSs won't be worthless, most people pay their mortgages after all. The problem with that argument is that it could be a very, very long time before these assets "perform" - that is, justify their book (or accounting) value - and many of them won't (are effectively worthless). The lack of transparency is what is causing the uncertainty.
Anyway, the plan that went down the other day would have suspended FASB (Financial Accounting Standards Board - they set the rules that accountants in the US need to follow) rule 157. This is the rule that states that these assets need to be marked-to-market. Without that rule, banks are free to mark-to-model and that means we don't know what the assets are truly worth.
This is yet another crucial piece of a bad bill. If these banks are allowed to keep bad assets on the books at whatever value they decide, then investors and other banks will not be willing to invest (the banks need capital - a great solution to this problem would entail lot's of investors stepping in to shore up their balance sheets) and/or lend. That is the reason why we have a credit crunch.
This reminds me of the time that a friend decided to buy tickets to a Patriots playoff game back in the 90s - through a broker - at the time the $200 a ticket (cheap seats) was a pretty steep price. He didn't buy because he was a huge Pats fan, he was speculating. I offered to go to Foxboro with him to help him try to unload the tickets (theoretically for a profit) and bail him out on one ticket for $100 if we couldn't sell them. The market was flooded with scalpers and he was lucky to sell 2 of the 4 for a loss (maybe $150 apiece, can't recall exactly). The point here is that the market decides what the tickets are worth, not you or your friend or me. In his mind those tickets were "worth" at least $200 - that's what's on his balance sheet.
Pretending that they are valued at that price would allow him to borrow more money against those assets (this is a stretch, I'm just trying to tie it back into the current situation) and invest in other assets (MBSs, risky loans, credit card debt, foreign currencies). A better example might be someone that bought a house in the past few years, saw the market prices rising in their neighborhood and took out a line of credit (HELOC) on the house. They booked the value of the house in their mind at that inflated market value. As prices fall, they should mentally write-down the value of their primary asset (the house), but most people cannot do that psychologically. Instead they just think the prices will come back to where they "should" be.
The big difference being argued here is that the banks (amongst others) are suggesting that these assets will be worth more than the market price at some point in the future. This is in fact, the core of Paulson and Bernanke's justification for their approach to solving the problem. Surely all of the MBSs won't be worthless, most people pay their mortgages after all. The problem with that argument is that it could be a very, very long time before these assets "perform" - that is, justify their book (or accounting) value - and many of them won't (are effectively worthless). The lack of transparency is what is causing the uncertainty.
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