[Update Apr. 2, 2009, 9:15:]
Well, that didn’t take long: Marketwatch this morning:

Responding to pressure applied by lawmakers on Capitol Hill, the Financial Accounting Standards Board on Thursday voted unanimously to give auditors more flexibility in valuing illiquid mortgage assets that may have long-term value.

The new guidance, which is expected to boost bank operating profits when they report first quarter results later this month, alters so called mark-to-market rules, which require banks and other corporations to assign a value to an asset, such as mortgage securities, credit-card debt or student-loan investments based on the current market price for either the security or a similar asset.
Banks complain they can’t sell certain assets because of a lack of a market, but that the assets are not distressed and have strong cash flow.
Seeking to resolve this situation, FASB’s guidance allows banks and their auditors to use “significant judgment” when valuing the illiquid assets. [emphasis mine]

[Mar. 17, 2009, 19:28:]
There’s a quiet undercurrent in fixit schemes for the market which is, shall we say, interesting. It’s about the valuation of toxic assets. Everything depends on that.

I’ll backtrack for a moment. The reason the markets crashed in the first place was that a mass of mortgage assets turned out to be nothing but debts. They were wildly overvalued. But they’d been spread so thinly throughout the market that people started dumping everything just to be sure they weren’t holding any of those loser “assets.” So the valuation of everything went down, good and bad. Banks, of course, have to have reserves of a certain magnitude, but their portfolios were now worth way less, just like everyone else’s. If banks can’t meet their reserve requirements, they’re considered insolvent.

So the banks started pointing out that their assets really aren’t that bad. They’re undervalued. The market’s not paying what they’re worth. It’s not fair!

Well, yes, they do have a point. Only some of their assets are toxic, not all of them, but the markets price them as if there’s a pox on them all. The problem is that a markets share one feature with democracies: they may be the worst pricing system, except for all the others. How else are you going to do it? Have a government body study each thing for sale and decide how much can be charged? Do it by vote? Freeze prices at, oh, for instance, 1906 levels? It’s no more arbitrary than settling on 2006.

Obviously, none of that could work. So the banks have an idea.

The banks will tell us what their assets are worth! It solves everything! They know their assets better than anyone else. They’ll put the right price on them, you betcha. And the amazing thing will be that all the banks will instantly become solvent again. It’ll be like magic. It won’t cost a thing. And so easy!

Politicians are nothing but helpless iron filings inside the magnetic field of any easy solution. This one is being seriously discussed. Personally, I’d bet money that they’ll implement it because it’s way too complicated an idea for CNN to dissect. I mean, it took me three or four paragraphs, and real news has to fit in about 8 seconds of the few minutes they give it. The whole thing will fly right under the popular radar, and the problem will seem to be gone.

Except, of course, that the problem — which was always misvalued assets — will be right where it has always been: in the banks rose-colored balance sheets, waiting for the next and even bigger implosion of fear because nobody knows what anything is really worth.

Mark my words, I shall watch our future progress with considerable interest. If the banks really are allowed to decide the value of their own assets, expect the markets to do a nice recovery followed by another panic a year or two down the road.

However, let me not close on a hopeless note. As I said, the banks do have a point. Some of their assets really are worth more than the market says. That does not mean that we should ever let the owner of any asset demand to be sole arbiter of what their goods are worth. Bit of a conflict of interest there. If you don’t see that, I have a Picasso in my attic that I’d like to sell you.

If the bankers’ only objection is that market fluctuations are masking the real worth of things, then smooth out the fluctuations. There are time-honored ways of doing that. You use what’s called a moving average. The market price over some span of time, such as 30 days or 30 years, is averaged. The span of time included in the average would vary for different asset classes, maybe a decade for real estate, maybe five years for stocks, and so on. The market still sets the price, the fluctuations are no longer a factor, and the banks don’t get to lead anyone down the garden path.

Oh, wait, that last item means the banks might still have a problem. Okay. Forget it.

markets, financial, crisis, mark-to-market, toxic assets