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Tuesday
Nov042008

Giving US financial institutions “relief” from “mark-to-market” accounting rules would not necessarily make them more credit-worthy or raise their share prices.

This report about Royal Bank of Scotland, which was permitted by a change in international accounting rules not to write down certain assets to market value, suggests those who would do business with RBS know the problems are still there no matter what the financial statements say.

Under US and international accounting rules, financial institutions are required to consider writing up or writing down the values of certain assets to reflect changes in market value. This is "fair value" or "mark-to-market" accounting. As the current credit crisis began to develop, markets for certain assets (e.g., mortgage backed securities, collateralized debt obligations, and credit default swaps) essentially disappeared as there were no buyers at all or buyers only at fire-sale prices of a few cents on the dollar. It is widely suspected that many financial institutions would be insolvent if they aggressively marked down assets to values for which they could actually be sold. This led to calls for mark-to-market accounting to be "suspended" and, naturally, the question of what valuation rules would apply during the suspension.

The International Accounting Standards Board issued a ruling that allowed RBS not to mark to market declines in value occurring after July 1, 2008. Apparently, this is done by reclassifying assets from tradable securities to "hold to maturity" status and then applying some different, but unexplained, valuation method. At least that's what RBS did. Apparently, there is some inhibition on selling hold-to-maturity securities when prices recover.

Is the alternative valuation method cost, face value, an estimate based on modeling, or perhaps just a SWAG? Presumably, that's explained in the footnotes to RBS's financial statements, but I don't care enough to dig into that, and maybe others don't either. It's just easier to make the judgment that the markets seem to have made—we're still worried about RBS's financial condition, so let's do business elsewhere.

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