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Misses the Mark: Mark-to-Market Accounting


Cash flow, not accounting, will ultimately determine the fate of banks.


Editor's note: The following entries on mark-to-market accounting originally appeared on Minyanville's premium product, the Buzz & Banter. They're being reproduced here for the benefit of the Minyanville community.

From Professor Sean Udall:

Some long-running angst may be relieved related to mark-to-market accounting. Remember, if this doesn't go through, we're going to new lows again.

We could repeal inverse ETFs, or at least restore position limits in futures. That would limit the committed dollars to these vehicles greatly. We could impose tighter margin rules on equity-related futures.

We could make CDS have to prove an insurable interest as a requirement, which would mesh with current insurance law. If this was done, many current speculative CDS contracts would be nullified.

So I'd contend we have quite a few bullets left, but the only other one I'd like to see used is the uptick rule. Since I believe CDS with M2M reform could become the banks' best friend and greatly juice net interest margin.

And how about a bullet to the rating agencies?

This is something Jeff Macke and others on Minyanville have railed about. Today we're seeing the totally inane ratings downgrades on JPMorgan (JPM) and other leading banks, which are crushing futures. This is yet another massive factor that leverages the damage caused by mark-to-market issues.

As many other Minyanville professors have stated, the ratings agencies were part of the bubble creation and now they're simply piling on and causing a lot more damage. Exactly what productive value to the global economy do these downgrades provide?

From Minyan Peter:

With the news that the House Finance Committee will look at mark-to-market accounting next week, I'd remind Minyans that what we're talking about is a change in accounting, not a change in cash flows. At the end of the day, it's the realized cash flows on loans and securities that will ultimately determine which banks survive. The accounting treatment -- whether accrual or mark-to-market -- just determines when the problems become obvious to investors.

I have no doubt that proponents of the suspension of mark-to-market accounting are banking on the stimulus package to turn the economy around sufficiently by late 2009 or early 2010 so as to make the accounting issue ultimately moot. And in that regard, this bears a striking similarity to the suspension of home foreclosures.

But from my perspective, these actions are likely to make bank financial statements and many government statistics meaningless for the foreseeable future as we draw the hospital curtain closed around dying patients.

I'm not saying miracles can't happen, but anyone considering this the bottom for financials had better be certain that the stimulus works - and more importantly that inflation kicks in with a vengeance.

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