Role of rule looms large

Leaning forward and gazing through silver-rimmed glasses while describing an obscure rule of bookkeeping, Bob Goodlatte wore the mien of a prim accountant, which, for the moment, is what Washington offers as Wall Street sways. Mark-to-market accounting regulations were the product of Enron’s wake; now they suck away air as banks gasp. And government dithers. Or so say Republicans, Goodlatte among them.

How does flawed accounting account for economic doomsday? This way: Mark-to-market accounting requires financial institutions to value assets at their market price, similar to the way reassessments like the one recently conducted in Augusta County are designed to assign home values based on sale prices. The rub when markets freeze is that market prices deflate and assets are valued artificially – and dangerously – low.

It goes deeper. When a bank sells at bottom prices, the effects ripple. Low sale prices force other institutions to decrease the value of their assets, or mark them to the market, or fire-sale, prices. Lower asset values lead to lower bank ratings, which in turn block either by law or charter investments from other institutions. Bankruptcy frequently follows, which for banks means liquidation, which starts the devaluation wheel spinning again.

By Jan. 2, the federal Securities and Exchange Commission is required under the bailout law approved a week ago by Congress, to complete a study of mark-to-market, or “fair value,” rules. By then, the lurching economy might crash to the floor. The SEC possesses the immediate authority to suspend mark-to-market restrictions, a move Goodlatte and banks support. “We need action on mark-to-market,” the eight-term congressman said Thursday during a visit to The News Virginian.

SEC Chairman Chris Cox’s hesitation has inspired calls for his firing, from Republican presidential nominee John McCain among others. The SEC has allowed institutions to relax mark-to-market rules in cases where no market evidence exists. The trouble is, market evidence is provided afresh with every bank failure. Suspending fair-value accounting – and allowing institutions to value assets based on purchase, or intrinsic, values – would “put trillions of dollars back into the lending pool,” Rep. Darrell Issa, R-Calif., told MSNBC.

But accountants, inclined under ordinary circumstances to speak softly and carry big pens, shout no. “Suspending mark-to-market accounting, in essence, suspends reality,” Beth Brooke, global vice chairwoman of Ernst & Young told the Wall Street Journal. Goodlatte concurs, to a point. “Fair-value accounting is a good thing,” he said. “But not in the current climate.”

The hazard of allowing banks wider discretion in valuing assets is that real weaknesses – or outright insolvency – might be veiled in a manner reminiscent of the savings-and-loan collapse two decades ago. Government intervention in the early 1980s helped mask the bleeding and delayed but could not stave off the demise of thousands of S&L’s. Badly weakened institutions cannot be sustained in perpetuity by mere accounting alchemy.

Neither, though, should it drive economic ruin. Government’s gaze is everywhere but is blind to transition. So government applies sensible rules rigidly, even when the moment of sensibility has faded. We are in such a moment now. Government should take notice and act swiftly: Suspend mark-to-market rules while the SEC studies the issue, and then revisit the subject when the clouds clear.