Mark To Market Accounting Changes Favor Banks
A few years ago, a change in bank accounting rules led to what is commonly known as “mark to market” accounting. Banks have balance sheets that are full of personal loans made to bank customers. These loans have value and are often resold on the secondary market. Historically, a bank balance sheet represented these loans as being worth the full dollar amount of the loan-a $250,000 loan, for instance, was valued at $250,000.
In 2007, the Financial Accounting Standards Board (FASB) changed the rules and determined that banks needed to list assets on their balance sheets at a value equivalent to their worth on the open market instead of simply at their face value. This decision received little protest at the time because most borrowers were making payments and the underlying collateral for the loan was gaining value. The last 18 months, as you’re well aware, have been a different story.
The headlines over the last several months related to the financial sector have been about write-downs and toxic assets. The mark-to-market accounting rule stated that banks needed to “write down” the value of outstanding loans to reflect that they could no longer be sold on the secondary market for their full par value. Instead, the value of many mortgage loans was determined to be between 30 and 60 cents on the dollar.
Thursday, the Financial Accounting Standards Board kicked off the second quarter with an announcement that they were relaxing the mark-to-market accounting rules for banks. Instead of having to show loan values as distressed prices, banks could now value loans at what their value would be in an orderly sale and a more normal market. This is a huge win for banks that had to raise billions of dollars in capital and accept bailout funds from the government in order to continue operations after writing down the value of their loan portfolios so heavily.
The announcement could have one unintended consequence that will be interesting to watch over the next few months. The federal government recently announced that they will partner with private investors to buy toxic assets from banks. The value of these toxic assets will increase as a result of the FASB decision on mark-to-market accounting, which could scare away private investors who were looking to buy loans at bargain prices and could also reduce the number of bad credit loans swept from bank balance sheets because each loan will be sold for a higher amount.
Overall, most of the financial world is viewing this decision as a positive way to help banks stay afloat while the rest of the economy begins the long road to recovery.
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Tags: FASB, Loans, Mark-To-Market, Toxic Assets
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