Just a quick query to readers of Paul Volcker´s Group of 30 regulatory restructuring proposal: How badly do you think he wanted to do away with mark-to-market accounting while he was writing it?
The question is relevant since he seems, during a conference at Vanderbilt University last weekend, to have turned up the volume on his criticism of fair value accounting practices.
Here is a transcribed excerpt from a Bloomberg News broadcast of Volcker´s comments during a question and answer session at the "Conference on Financial Markets and Financial Policy Honoring Dewey Daane on his 90th Birthday" on Saturday. Volcker said:
"Now we've had this crisis. What I think our weaknesses in the extreme mark-to-market fair value so-called approach are exposed. I was very frustrated because I never like the full scale application of it but I was told to shut up because I was not supposed to opine on technical matters...I do think in the current disturbed situation you have and did have in the markets where it´s hard to know the value of complex instruments, pushing mark-to-market accounting to an extreme is a mistake.
"It can lead to a cascading decline in valuations. It certainly led to inconsistencies among institutions. But beyond that I think there is a more fundamental problem. Is mark-to-market accounting really consistent with the traditional banking system, and I can say insurance companies and pension funds as well. All regulated institutions that perform a vital economic function of transferring maturity and credit differences into a practical, money-making operation, they are intermediaries.
"You can't intermediate if you can't take any maturity differentials or if you can't take any credit risk. I'm exaggerating a bit, but mark-to-market accounting forces you not to take maturity risk, not to take credit risk, and everything becomes very volatile in the open market which is what was happening.
"Does that degree of volatility really solve the economic interest and stable and orderly economic growth? And I think the answer to that is no, projected over the whole financial system. But yes, there is a reason to have an accounting system that recognizes the needs and importance of intermediation in the credit markets by regulated institutions."
Compare that with the text of the G30 report, which included this passage:
"Apart from the current difficulties in determining market prices, there is an underlying tension between the business purposes served by regulated financial institutions-particularly those in which the basic function is to intermediate credit and liquidity risk by funding illiquid loans by means of demand or short-term deposits-and the interests of investors and creditors to have the best possible current information on the immediate market value of assets and liabilities. That tension has also been reflected historically in different approaches favored by prudential and security regulators. The direction until recently has been to seek to resolve that tension by forcing as much of the accounting and valuation of all assets and liabilities as possible into an accounting model designed and developed to address market values of liquid tradeable instruments.
"The extent to which this represents a "forced fit" has become very apparent in the current crisis. One dramatic result has been the ability of distressed institutions to increase their reported earnings by marking to market of certain of their own liabilities as the credit risk on their debt has increased. Another problem is valuations on illiquid assets that sometimes have limited relationship to expected discounted cash flows. The way forward is not to abandon appropriate consideration of fair value principles but to seek a better principles-based balance between the legitimate needs of investors for useful current financial information and the business model of the regulated financial institutions."
Well? New or not new? BankThink´s inclination is to chalk it up to the casual nature of speech as opposed to the formal constraints of writing. But some of our readers may disagree.