Saturday, February 7, 2009

Time to delete mark-to-market?

There were rumors on Friday that the mark-to-market rules might be relaxed, and those rumors were credited with the rise in bank stocks.

Which leads to the question, why are those rules still in place? There have been suggestions throughout the financial panic that the mark-to-market rules were one of the things that was accentuating the fall. And if we look at how the Federal Reserve has responded, we can see that this financial panic is like no other. What is different this time? Could it be that the mark-to-market rules have introduced amplifying feedback, making the financial crisis a self-feeding process?

When FDR became president, his administration was a lot like the character in a comedy reacting to a crisis by pushing buttons. FDR pushed a lot of wrong buttons, but he did push one correct button by severing the tie to gold and eliminating the Fed from monetary policy, which had established an amplifying feedback loop in monetary policy. Maybe the mark-to-market button is the right one this time. Certainly it is worth trying. If the U.S. is willing to spend nearly two trillion dollars, the amount of the TARP and the so-called stimulus plan, why would it not also be willing to junk a rule that costs virtually nothing at all to junk? I wonder why the Bush administration was never willing to take this simple step given that they were willing other steps that were far more drastic.

Economics lacks a consensus framework in which to view macroeconomics. A framework of shocks and feedback, in which shocks knock the economy off path and the feedback accentuates the effect of the shock, leads one to focus on items like mark-to-market. The equilibrium approach of Keynesian economics leads to a focus on stimulus packages. If we get both a stimulus package and an elimination of mark-to-market, it may be very difficult to distinguish the effects of each.

Update Feb 16, 2009: Brian Wesbury, chief economist at First Trust Portfolios L.P., argues in a National Review piece, "Untouchable Accounting Rules? Really?", that mark-to-market has been a major contributor to the current crisis because of its procyclical feedback properties, and needs to be eliminated. He points to some history:
Fair-value accounting as we know it today is based on rule FAS 157, which was implemented by the FASB in 2007. But it has a longer history than that. Fair-value accounting existed in the 1930s, which was when we had the Great Depression. In 1938, President Roosevelt suspended those rules, and between then and 2007 the economy had no panics or depressions. Maybe its time we put fair value through the shredder once again.

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