The bill that failed yesterday had a provision that allowed the SEC to suspent mark to market accounting rules. This story from MarketWatch has details:

SAN FRANCISCO (MarketWatch) – Congress is looking at playing with mark-to-market accounting rules as part of the now-stalled $700 billion-dollar bailout plan for the U.S. financial system.
A provision in the bill, whose adoption was in doubt after the House of Representatives rejected it Monday, gives the Securities and Exchange Commission the right to suspend — by rule or order — mark-to-market accounting under Statement Number 157 of the Financial Accounting Standards Board.
The SEC would be allowed to step in front of mark-to-market accounting standards if it was in the public interest and consistent with the protection of investors, the House bill said.
I favor this as an alternative to the $700 billion slush fund, but there are problems with suspending these rules. Suspending mark to market would allow banks to carry loans on their books at a value that is closer to the so called hold to maturity value. The problem is that hold to maturity value is an unknown. To calculate that value you need to know the default rate and recovery rate for every mortgage in the pool. So allowing banks to just guess at those values gives them too much leeway to cook the books. Furthermore, this is similar to what the Japanese did back in the 90s. These banks would be left with the toxic assets on their balance sheets and would still have problems raising new capital. Would you invest in a bank when you don’t know the real value of the assets on their balance sheet? I didn’t think so.
Having said all that, suspending mark to market is a much better idea than using taxpayer dollars to buy the mortgages from the banks at those inflated hold to maturity values. The best plan is still to just let the bad banks fail and be taken over by the strong banks. That gets rid of the executives who made the lending errors and rewards the executives who acted prudently. Isn’t that the kind of incentive we want in the market?
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