As the economic crisis has deepened over the last several weeks, a number of knowledgeable people have told me that the simplest thing the government could do that would have a significant effect on the availability of credit is to ease the “mark to market” rule. A couple of hours ago, the SEC did just that.
Technically the SEC issued a clarification of the rule, to the effect that banks are not necessarily required to write assets down to the current market level. Rather, “[w]hen an active market for a security does not exist, the use of management estimates that incorporate current market participant expectations of future cash flows, and include appropriate risk premiums, is acceptable.”
The mark to market accounting rule has been a significant cause of the drying up of credit. Currently, there is no market for a broad range of financial instruments that are backed by mortgage portfolios. Under the old version of the rule, banks had to value such assets at zero. That’s not right; most of them ultimately will have value. But currently, given the uncertainties surrounding the subprime market and some of the instruments themselves, no one wants to buy them.
The effect of such asset write-downs is that the amount of money the bank is allowed to lend is reduced. Thus, the SEC’s clarification to the rule should have the effect, in the immediate future, of freeing up a considerable amount of credit.
The real threat to the broader economy comes from the freeze-up of credit markets, not the fact that a few private institutions that gambled heavily on mortgage-backed securities may go broke. If revision of the mark to market rule has as much impact on credit markets as many have predicted, it may strengthen the resolve of those who think there are better solutions to the problems in our financial markets than a $700 billion bailout.
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