Mark-To-Market / It’s Time To Gore Sarbanes-Oxley Now
In the wake of the ENRON Corporation accounting fiasco, congress rushed in with the passage of the Sarbanes-Oxley Act of 2002 to show that they were paying attention to the outrage seen in the voting public to lying from corporate executives.
Definition from Wikipedia:
The Sarbanes-Oxley Act of 2002 (Pub.L. 107-204, 116 Stat. 745, enacted 2002-07-30), also known as the Public Company Accounting Reform and Investor Protection Act of 2002, enacted on July 30, 2002 was put forward by Congress in response to a number of major corporate and accounting scandals including those affecting Enron, Tyco International, Adelphia, Peregrine Systems and WorldCom. Named after sponsors Senator Paul Sarbanes (D-MD) and Representative Michael G. Oxley (R-OH), the Act was approved by the House by a vote of 334-90 and by the Senate 99-0. President George W. Bush signed it into law, stating it included "the most far-reaching reforms of American business practices since the time of Franklin D. Roosevelt."
Tucked into this bill was an accounting practice that is known by the term “Mark-To-Market”. “Mark-To-Market” was designed to have assets of a corporation be valued on a market valuation basis. Simply put … the assets of a corporation would be valued not on the time and intrinsic value of the assets held, but on the confidence level of those assets as shown in the stock market price of the company marked at a particular point in time.
Several recognized leaders have begun to ask the Bush Administration to act against this practice and change it so that the value of corporate assets would be calculated based upon an average taken over a three month period backwards from the time the assessment is required when businesses are applying for swing loans upon which a company takes advantage of an opportunity to expand (leveraging assets).
Newt Gingrich, Donald Trump, and Steven Forbes are three of the recognized names calling for this free market change upon which about 70% of our economy’s liquidity crisis can be solved. By making the Executive Order TODAY to suspend the “Mark-To-Market” accounting practice of corporate valuation mandated by the Sarbanes-Oxley Act, corporations would be able to show assets valued at a more realistic rate thus banks would have the confidence to lend them money and our economy would gain some liquidity without taxpayer money.
This excerpted and edited from Forbes Magazine -
Suspend Mark-To-Market Now!
Newt Gingrich 09.29.08, 6:05 PM ET
Today, Congress voted against passing the bailout package for Wall Street. The stock market reacted immediately, falling almost 800 points. It is clear that something needs to be done, and in the coming days, a new package must be constructed that has the support of the American people that both deals with the liquidity crisis and sets the stage for long-term economic growth.
Today the Treasury secretary released the following statement: "I and my colleagues at the Fed and the SEC continue to address the market challenges we are facing on a daily basis. I am committed to continuing to work with my fellow regulators to use all the tools available to protect our financial system and our economy."
While Congress and the White House consider next steps, the Treasury and its fellow regulators should follow their own counsel and take without delay the one regulatory action within their discretion that can help immediately to calm markets and dramatically reduce the taxpayer risk in any necessary government intervention: suspend mark-to-market.
Chief economist Brian S. Wesbury and his colleague Bob Stein at First Trust Portfolios of Chicago estimate the impact of the "mark-to-market" accounting rule on the current crisis as follows:
"It is true that the root of this crisis is bad mortgage loans, but probably 70% of the real crisis that we face today is caused by mark-to-market accounting in an illiquid market. What's most fascinating is that the Treasury is selling its plan as a way to put a bottom in mortgage pool prices, tipping its hat to the problem of mark-to-market accounting without acknowledging it. It is a real shame that there is so little discussion of this reality." (Emphasis added.)
"Mark-to-Market" Accounting and the Origins of the Financial Crisis: Mark-to-market accounting (also known as "fair value" accounting) means that companies must value the assets on their balance sheets based on the latest market indicators of the price that those assets could be sold for immediately. Under such a rule, declining housing prices don't just reduce the value of defaulting mortgages. They reduce the value of all mortgages and all mortgage-related securities because the housing collateral protecting them is worth less.
Moreover, when a company in financial distress begins fire sales of its assets to raise capital to meet regulatory requirements, the market-bottom prices it sells out for become the new standard for the valuation of all similar securities held by other companies under mark-to-market. This has begun a downward death spiral for financial companies large and small.
More foreclosures and home auctions continue to depress housing prices, further reducing the value of all mortgage-related securities. As capital values decline, firms must scramble to maintain the capital required by regulation. When they try to sell assets to raise that capital, the market values of those assets are driven down further. Under mark-to-market, the company must then mark down the value of all of its assets even more.
The credit agencies see declining capital margins, so they downgrade the company's credit ratings. That makes borrowing to meet capital requirements more difficult. Declining capital and credit ratings cause the company's stock prices to decline.
Panic sets in, and no one wants to buy mortgage-related securities, which drives their value under mark-to-market regulations down toward zero. Balance sheets under mark-to-market suddenly start to show insolvency. This downward spiral shuts down lending to these companies, so they lose all liquidity (cash on hand) needed to keep company operations going. Stockholders--realizing that they will be wiped out if the companies go into bankruptcy or get taken over by the government--start panic selling, even when they know the underlying business of the company is fine.
The end result for the company is stock prices driven toward zero and bankruptcy or government takeover. The criminal liabilities imposed under Sarbanes-Oxley have driven accountants to stricter and stricter accounting evaluations and interpretations and have prevented leading executives from resisting them.
Reform or Bust: Because existing rules requiring mark-to-market accounting are causing such turmoil on Wall Street, mark-to-market accounting should be suspended immediately so as to relieve the stress on banks and corporations. In the interim, we can use the economic value approach based on a discounted cash flow analysis of anticipated-income streams, as we did for decades before the new mark-to-market began to take hold. We can take the time to evaluate mark-to-market all over again. Perhaps a three-year rolling average to determine mark-to-market prices would be a workable permanent system.
For companies like Bear Stearns, Lehman Brothers (nyse: LEH - news - people ) and American International Group (nyse: AIG - news - people ), suspending mark-to-market rules will come too late. But for the remaining vulnerable banks and corporations, doing away with the current mark-to-market accounting rules will safeguard against destructive pricing volatility, needless bankruptcies, job loss and huge taxpayer bailouts.
Suspending Mark-to-Market Only the First Step to Economic Recovery: In the wake of today's vote, suspending mark-to-market is an extremely important first step to take, but it is only a first step.
Congress should look at the impact of the Irish 12% corporate income tax on attracting investment and jobs to Ireland and consider a dramatic cut in the U.S. corporate income tax (the highest in the world when combined with state taxes) as a step toward attracting high-value productive and desirable jobs back to the United States.
The Congress should look at the Chinese and Singapore growth patterns and match them by zeroing out the capital gains tax to induce massive flows of private capital to rebuild the market and minimize the need for a taxpayer-funded bailout.
The Congress should repeal Sarbanes-Oxley, which failed to warn of every single bankruptcy but provides a $3-million-a-year accounting and regulatory expense for every small company wishing to go public.
This is the kind of pro-growth, pro-entrepreneur program that would accelerate the American recovery and lead to the next economic period of real growth.
It’s time to gore Sarbanes-Oxley now!