Sunday, February 8, 2009

How the Mark-to-Market Rule affects Economic Recovery

I have written about the mark-to-market rule aka fair value accounting on several occasions here.

Economic policy-makers should pay heed to the view that the mark-to-market rule (for easy writing I dub it the "m2m rule") hinders economic recovery efforts. I take this view.

Basically, the m2m rule requires accountants in banks and corporations to review the value the assets of securitised assets and assets of corporations based on prevailing market prices.

How the m2m rule affects economic recovery efforts
One of the key factors that affect economic stimulus packages in Western counties, particularly, the U.S., has been the valuation of securitised assets in the books of banks. I have offered one radical solution of legislating to fix the valuations of toxic assets here. So far, no takers.

There are 2 areas where the m2m rule has an adverse effect on economic recovery efforts:

First, in a contracting economy banks that comply with the m2m rule will constantly be downgrading the valuation of securitised assets. When this is coupled with the borrower company's poor sales turnover and declining profits, it can only mean that when the risk management software kicks in, the banks will want the borrower to top-up the securitsation. Worse still, the banks may regard the loan as non-performing. The loan becomes an NPL.

To be fair, Bank Negara has agreed that Malaysian banks defer the m2m rule. I have forgotten how long the deferment is for.

Second, the m2m rule will impact publicly-listed companies ("PLCs") at Bursa Malaysia. If the time-table set by the Malaysian Accounting Standards Board ("MASB") is strictly adhered to, by Jan 1, 2010 the m2m rule will kick in for most key Malaysian business sectors. When this happens, there is a strong possibility that it will have an adverse effect on economic recovery efforts.


Accountants and the Bridge Over The River Kwai Syndrome
The global accounting fraternity has worked very hard since one of their greats, Arthur Andersen died an unnatural death in the wake of the Enron and Worldcom scandals.

The m2m rule is the fruition of hundreds and thousands of man-hours of committee- and sub-committee meetings by accounting standards boards throughout the world. Officially, the m2m rule is known globally as International Accounting Standard (IAS) 39 or, in Malaysia as Financial Reporting Standard (FRS) 139.

After such a Herculean effort, where the accounting fraternity even managed to rope in the U.S., to agree to the accounting standard the accounting fraternity will not yield easily to the deferment of the m2m rule.

As recently as in this month's issue of In the Black, the magazine for CPA Australia, its CEO Geoff Rankin wrote in defence of the m2m rule. In November last year, the ACCA had supported MASB's defence of the time-table for the m2m rule.

I call this the Bridge Over The River Kwai Syndrome. A case where, after so much effort being put into an endeavour, one cannot imagine changing or, re-directing or, defering the implementation of the end-product.

Where the m2m rule fails
My proposition is that the m2m rule only works when there is a stable economic environment. Where economies expand and contract in the ordinary course of cyclical movements, the m2m rule works quite well, I think.

The m2m rule is intended to ensure that all stakeholders of banks and corporations have accurate financial information in order to formulate their business plans and investment decisions.

The m2m rule fails when there is a very dire economic situation such as the one confronting the whole world.

Let's be frank. The m2m rule, to paraphrase the Jack Nicholson character in the movie As Good As It Gets, only describes the water when everyone is drowning. Geoff Rankin's analogy was that just as you can't blame the thermometer for the Australian heatwave, you can't blame the m2m rule for the economic crisis.

Is that accurate?

The nightmare scenario is that the m2m rule creates a self-fulfilling prophecy. It triggers off a pro-cyclical vicious cycle at a time when economic policy-makers are trying to create a counter-cyclical virtuous cycle through economic stimulus packages.

The dilemma is that accountants, being fearful of tortious and statutory liabilities, will adopt a conservative stance and refuse to exercise broader judgement in applying the m2m rule. The International Accounting Standards Board (IASB) has, in the wake of the U.S. fiasco, attempted to stress the importance of the use of judgement in applying the m2m rule by releasing guidance in October 2008 on how to determine fair value when markets are illiquid. But, such guidance ring hollow to accountants who would naturally prefer to exercise zero judgement i.e. take a very conservative view on fair valuation rather than to run the gauntlet of liabilities for having exercised broader judgement.

So, I say, please defer the implementation the the m2m rule until genuine economic recovery kicks in.

One final reminder, the MASB deadline for the full implementation of the m2m rule is Jan 1, 2010.


walla said...

etheorist said...

I agree.

My objection to mark-to-market rule is that it accentuates the volatility in the economic system.

The stock market is supposed to be an alternative to the banking system for funding of the private sector. When shares can be used as collaterals for additional loans from the banks, there is a double funding of the stock market. This brings greater instability to the whole economic system. The problem is brought home to bear more in the downswing than in the upswing.

The traditional conservative method is to value shares at par. But then when bankers have forgotten how to be bankers and they collude with businessmen to make quick easy profits, they in effect threaten the economic sytem with their lack of wisdom.

de minimis said...

bro walla

As always, your references are incredibly useful.


I am greatly encouraged by your views.