A congressional subcommittee has scheduled a hearing Thursday on the federal government’s mark-to-market accounting rule, which has become a flashpoint for many commercial real estate investors. Critics say the rule weakens investors’ and institutions’ financial position and contributes to the economy’s downward debt spiral.
“Enough people have raised the issue that it’s made it up the priority list — I believe it to be a critically important issue,” says Edward Padilla, CEO of Northmarq Capital, a commercial real estate brokerage and management firm based in Minneapolis.
Padilla contends that the accounting rule has required devaluation of a performing asset class that was not meant to be treated like a security. Some companies, particularly those that own commercial mortgage-backed securities, have been forced to mark their assets at fire-sale prices, he says.
Federal Reserve Chairman Ben Bernanke on Tuesday made a strong statement in favor of adjusting mark-to-market accounting rules. "We need to provide more guidance to financial institutions about what are reasonable ways to address the valuation of assets that are traded at all in highly problematic markets," Bernanke said. He made the remarks while spelling out a strategy to avert future financial crises. After the Fed chairman’s remarks, the Dow surged by 5%.
Mark-to-market accounting requires valuing assets at current market values, but that standard has forced some companies to write down billions of dollars worth of assets, which has caused ripple effects elsewhere in the marketplace, according to Congressman Paul Kanjorski (D-Pa.), chairman of the House Financial Services Subcommittee on Capital Markets, Insurance and Government-Sponsored Enterprises, which is holding the hearing.
“Illiquid markets have resulted in great difficulty in valuing sizable assets,” Kanjorski said in a statement. “While companies need stability, investors still need accurate information. We therefore cannot allow for fantasy accounting that wishes away bad assets by merely concealing them,” he added. “I want to find a way — within the existing independent standard-setting structure — to still provide investors with the information needed to make effective decisions without continuing to impose undue burdens on financial institutions.”
Some auditing and consumer groups, including the Consumer Federation of America and the Council of Institutional Investors, have expressed “grave concern” over requests for the Securities and Exchange Commission to suspend fair value accounting requirements of the Financial Accounting Standards Board 157 mark-to-market rule, saying that changes to the rule would harm the credibility of the federal standards and would not be in the public interest.
However, for assets that are frozen and have a diminished current market value but may recover value in the future, the requirement for basing value on today’s market has posed a problem, Kanjorski noted.
“If an institution has mortgage-backed securities, and those securities are still paying, why should we cause that institution to become insolvent through accounting rules?” Padilla asks. “If they have cash flow to cover their liabilities, leave them alone.”
For banks, the situation is different, particularly if the bank has strictly short-term liabilities, and clients are allowed to withdraw their money immediately, Padilla says. Mark-to-market rules should be matched with the type of institution, he adds.
“You have to understand that no one is going to become a lender or put out capital, or be a buyer — all the things you need to have happen to turn the economy around — until they have confidence in their own financial condition,” says Padilla. If they are under pressure to write down billions of dollars of assets, the institutions will remain frozen, he adds.
As long as an institution invested wisely and didn’t buy subprime loans — if it is receiving payments, has fundamentally sound assets and hasn’t been downgraded by the rating agencies or defaulted on loans, that company should not be forced to write down its assets at 50 cents on the dollar, adds Padilla.
At Thursday’s subcommittee hearing, two panels will address the mark-to-market issue. The first panel includes James Kroeker, acting chief accountant of the Securities and Exchange Commission; Robert Herz, chairman of the Financial Accounting Standards Board, and Kevin Bailey, deputy controller for regulatory policy at the Office of the Comptroller of the Currency.
The second panel includes Jeff Mahoney, general counsel of the Council of Institutional Investors; Cindy Fornelli, executive director of the Center for Audit Quality; Thomas Bailey, chairman of the Pennsylvania Association of Community Bankers; and Lee Cotton, former president of the Commercial Mortgage Securities Association, among other speakers.