Wednesday, September 24, 2008

WSJ and the mark to market issue

The lead editorial in the Wall Street Journal is cautiously supportive of a toned down Paulson rescue plan, not toned down in terms of the money requested but in the rationale and administration of it. Written by the free market zealots at that paper, commentary on mark to market accounting in this editorial rankled me to the extent that here's one more comment on that issue that I'm getting sick of writing about. To quote the WSJ's editors:
"Another misconception is that the credit problem will vanish if only Treasury suspends 'mark to market' accounting-as if those bad assets wouldn't still exist...Mark to market has surely contributed to this mess and needs to be revisited. But to toss it aside wholesale now would risk turning banks into the zombies of Japan's lost decade."

Red herring, smells like it. No one, absolutely no one is suggesting "tossing it aside wholesale". Mark to market is appropriate accounting in normal or reasonable volatile markets. The rules as they exist now have an achilles heel that is stomping the markets. The WSJ is correct when it says the rules "need to be revisited", but this is not like a stroll to Grandma's house when the leaves begin to turn. It is urgent.

The flawed parts of the rules can be revised and all of the good parts kept. Revising could be complex and require some creativity. That should be no big deal for financial markets that have created complex derivatives and securities for two decades and a U.S. government that can come up with and administer one of the most convoluted, complex and in some aspects inexplicable tax codes in the world.

Simple idea, maybe Forest Gump like, but here goes. Keep mark to market accounting as is but with this change. When market volumes for an individual security, or set of like securities, are trading below 20% of historic volumes as measured over a two year period, require any new marks to be at least at that 20% volume level. Pick any % that you want, and any historic period that you want, but plug them in. It would mean that the last distressed seller near bankruptcy would not set the price for all of that security or set of securities.

There are ways to come up with a solution. It seems that for their own philosophical or self serving reasons that the WSJ wants no part of this.


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