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Mark to market accounting impact at financial crisis

Mark to Market or fair-value accounting requires companies to record assets every quarter to reflect market value. Therefore, some CEOs companies claim that the standard had aggravated the worst financial crisis since the Great Depression. On the other hand, the new regulation provides investors a frank look at the company’s earnings. (Bloomberg, 2008)

Those arguing for change include some of the companies distressing the most since the subprime-mortgage crisis had started in 2007, including Citigroup and American International Group Inc. Critics, who said the mark to market doesn’t work when there are no buyers for assets whose value has fallen significantly, include Schwarzman, that manages the world’s largest private-equity fund and whose shares have dropped 72 percent with the financial crisis. (Fortune, 2008)

Schwarzman said at the discussion hosted by Fortune magazine at Per Se. “The rule and the way it’s been implemented has been a major contributor to the financial crisis.” He also criticize, that mark- to-market accounting wrongly makes them to price holdings even if they have no intention of selling them at that time, hindering the business model of fixing up companies and disposing of them years later for a profit. (Fortune, 2008)

Supporting the idea, Citigroup Senior Vice Chairman William Rhodes and Deutsche Bank AG Chief Executive Officer Josef Ackermann spoke in October, 2008 in Washington on behalf of the Institute of International Finance, said the rule needs a review because it doesn’t work in illiquid markets. Moreover, in an article of WSJ.com Steve Forbes wrote that “the idea seems harmless: Financial institutions should adjust their balance sheets and their capital accounts when the market value of the financial assets they hold goes up or down. That works when you have very liquid securities, such as Treasurys, or the common stock of IBM or GE.”(Wall Street Journal, 2009)

Investors and accountants like the former Securities and Exchange Commission chief Arthur Levitt mocked at those claims, saying the mark-to-market regime provides a very important precision into companies' financial health. The surge of writedowns, they argued, reflects the poor economic judgments made for the period of the boom that ended last year. (CNN Money.com, 2008)

On the other hand, there were also people like the Real Estate Billionaire Sam Zell, Chairman of Equity Group Investments, who said without mark-to-market, this crisis would never have reached such a high level. According to Windows Financial Service article, he was not the only one to complain about SFAS 157, but also Martin Sullivan, the former CEO of AIG, confirmed before the U.S. Congress that the accounting rule generated tens of billions of dollars in paper losses for AIG, which end up in the insurer’s financial crisis and following bailout by the U.S. Treasury. (Windows in Financial Service.com, 2009)

On the other side, defenders of SFAS 157 argue the financial market needs the transparency generated as a result of the accounting rule and that any deferment of the rule would make more financial instability. Financial Accounting Foundation Chairman Robert Denham notified to (D-MA) that “any legislative effort to overturn [SFAS 157] will greatly undermine investor confidence.” (Windows in Financial Service.com, 2009)

In response to this debate, Congress consented that the Securities and Exchange Commission develops a study on SFAS 157. Therefore, after reviewing three years’ worth of financial data for 22 failed banks, The SEC stated in its report that the existing financial crisis was not caused by the new rule SFAS 157:

“Rather than a crisis precipitated by fair value accounting, the crisis was a ‘run on the bank’ at certain institutions, manifesting itself in counterparties reducing or eliminating the various credit and other risk exposures they had to each firm…The Staff observes that fair-value accounting did not appear to play a meaningful rule in bank failures occurring during 2008. Rather, bank failures in the U.S. appeared to be the result of growing probable credit losses, concerns about asset quality, and, in certain cases, eroding lender and investor confidence”. (SEC.gov, 2008) For the failed banks that did recognize sizable fair value losses, it does not appear that the reporting of these losses was the reason the bank failed. (SEC.gov, 2008)

The ended of Global Financial Crisis?

After a series of financial stabilization policies, financial rescue plan followed by regulatory reform, the market seems restored from the peak of the financial crisis. Good news like stock market is “back to normal” featured by the generally rise in stock price, for example HSBC share price was $73.36 in Sept 2008 and sharply fell to $23.07 in Mar 2009 while restored to $49.53 in Jul 2009 which showed the rebuild of consumer confidence on stock market and moved up of consumer confidence index brought new hope to the public (M, N, Baily and D, J, Elliott 2009). Some political leaders even claimed the crisis is nearly over by July 2009; however, it is too optimistic and too early to make this conclusion.

According to the data of Bureau of Labor Statistics of America (2010), the unemployment rate in the US soared from 5.81% in 2008 to 9.28% in 2009 and steadily increased to 9.7% in March 2010 and the data shows that “employment continued to decline in financial activities”. However, consumption is one of the crucial components in GDP; constantly low consumption volume will affect the growth in GDP. If unemployment rate continuing increase, consumption will decrease while immediately affect the sales and profit of company; once the company go bankrupt, it became the ‘toxic asset’ to bank, which forms a vicious circle. High unemployment rate is a world issue after the crisis, Europe countries like Germany (8.2%), France (9.7%), Greece (9%), Italy (7.5%), European Union (9.2%) Spain (18.1%) and Ireland (12%) suffered from this problem (Central Intelligence Agency 2010). For the phenomenon of high unemployment rate with low level of consumption lead to the shrink of economic development in a country and sow a seed for another wave of credit crisis.

Chart 1 (Source: Federal Housing Finance Agency)

The global financial crisis could be traced back from the housing bubble in the US, after the introduction of stimulus policy, the US FHFA House Price Index rise from nadir in the Q4 2008 to a better level in Q4 2009 (Chart 1), however, it doesn’t mean that the crisis was passed. The main reason for the restore of the housing market was driven by the first-time home buyer tax credit which extended its expiry date from November 2009 to April 2010 (Tanrich 2010). Therefore, the increase in house price and active housing market could be an illusion. The US government held a large amount of CDOs and CDSs in national balance sheet which were built base on the housing mortgage debt; the lower the housing price in the US market will directly affect the decrease in value in those toxic securities and remains a great burden to the US government. Economist Karl Case said “We’ve turned a corner with housing, though it’s hard to see any robustness” (Bloomberg 2010), therefore, US is still under the shadow of financial crisis while there is long way to restore its housing market.

By the extension of financial crisis from the US, Eurozone is heavily suffered as all countries tightened their credit loans which lead to debit crisis in Europe. Standard and Poor’s has downgraded Greece sovereign credit rating to junk status followed by Portugal downgraded to A- and Spain’s credit status to AA with negative outlook (Bloomberg 2010), Greece is at the margin to go broke under the crisis. Although Greek government tried to halt the huge fiscal deficit by issuing government bonds, unlike the situation in the US, no country is willing to hold the fallen knife as the total volume of deficit cannot be estimated with poor sovereign credit.

However, by the threat of broken of Eurozone, the main leader-Germany in the Eurozone and IMF delivered 45 billion-euro loan to Greece. The loan may alleviate Greece’s economy temporary, however, without any economic reform on the financial system in Greece, the loan will be only a tranquilizer used to postpone the new wave of economic crisis in Europe. As Lena Komileva, head of G7 market economics at Tullet Prebon said that “Greece’s credibility and credit crisis is not over yet” (Financial Times 2010). Greece’s situation is not an isolated case among 27 countries in EU, while 20 countries in EU have serious deficit which evidenced the global financial cannot be claimed as an end in 2009.

To conclude, the US financial market as well as global market still fragile and under the shadow of the financial crisis, high unemployment rate becomes global phenomenon while the continuity on the increase in the US housing price is doubted together with the spread of debt crisis in Eurozone proved that the ended date of financial crisis is uncertain, the global financial markets have long way to restore to pre-crisis situation.

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