Local banks provide the responsible loans families need to purchase homes and send their kids to college. They also work with local businesses to provide funding that expands businesses and creates jobs.
The strength of these local relationships is one reason community banks have weathered the economic crisis far better than larger institutions. But even the sturdiest community banks are at the whim of mark-to-market accounting, which distorts the values of the securities these banks hold — securities backed by the mortgage, consumer and student loans that keep their communities running.
This problem appears to finally be under serious review by the Financial Accounting Standards Board. This late but badly needed FASB move is clearly a reaction to a March 12 House Financial Services hearing. The new FASB guidance has the potential of providing some rationality into the too-theoretical mark-to-market accounting rules. Let's hope this proposal is swiftly and precisely addressed at the next FASB meeting. As Rep. Gary Ackerman of New York stated at the hearing, "We simply cannot wait any longer for some substantive action to be taken to help institutions understand how to record illiquid assets."
Current mark-to-market accounting requires that banks adjust their balance sheets according to the market values of the assets they hold. This accounting principle was meant to create transparency by providing a rational view of the value of assets. There is no doubt that transparency is important; the failures of overleveraged investment firms such as Lehman Brothers and Bear Stearns have shown us this.
But under the strains of the current economic environment, where the markets for mortgage-backed and asset-backed securities are frozen, if not downright broken, these accounting principles have gone beyond providing a rational view and stepped into the realm of theory. What else but theory can be used when attempting to mark the value of assets to a market that no longer exists?
Community banks are built on the foundation of making conservative, responsible loans and purchasing safe, liquid assets that they will hold on their balance sheets, often to maturity.
But in this economy, even the market for the triple-A-rated bonds these banks purchased has dried up, even as the underlying mortgages in many of these bonds still generate income. This should not present an issue for community banks, which have the ability, and often the intent, to hold these bonds until the market returns and they reclaim their value. But under the mark-to-market structure, banks are often required to take other-than-temporary impairment charges on many of these assets, forcing banks to value assets at current, deflated values and taking a loss, rather than recognizing the long-term value these assets will have as the economy stabilizes. Mark-to-market principles assume the worst, the banking equivalent of a doctor telling an otherwise healthy patient that he is dying just because his sore throat could turn into a cough that could turn into pneumonia that could result in death.
These drastic OTTI charges affect not only banks, but the communities they serve. Institutions are hesitant to purchase assets that they may have to unnecessarily write down at a later date; they are equally hesitant to sell assets at a loss at such deflated prices. The resulting market standstill, combined with the OTTI charges banks have already been forced to take on otherwise healthy assets, leads to strains on banks' capital, which means less capital available to fund the home, consumer and student loans their communities rely on.
The local bank is a vital source of lending, and it is through an increase in responsible lending that the economy will begin to recover. But banks need to operate free of the rigid confines of mark-to-market accounting principles to be able increase their lending. Mark-to-market accounting currently presents a distorted view of a bank's financial health, instead of the clear picture that it was intended to provide. This murkiness is not what the economy needs.
