March 4 (Bloomberg) -- Nothing has done more to disturb financial markets in recent months than the huge writedowns in the value of bank assets related to subprime mortgages. Some of them may have gone too far.

Federal Reserve Chairman Ben S. Bernanke said in congressional testimony on Feb. 28 that accounting rules may be forcing banks to put artificially low values on little-traded assets when they mark them to market.

The inability to value such assets on the basis of actual trades, Bernanke said, is ``one of the major problems that we have in the current environment. I don't know how to fix it. I don't know what to do about it.''

Writedowns in the tens of billions of dollars have forced some large institutions, including Citigroup Inc., to raise new capital to offset losses and perhaps made them less willing to extend credit, hurting economic activity.

Some analysts, such as Richard Bove of Punk Ziegel & Co., say the tools banks are using to value their assets ``don't reflect the real world.''

``This mark-to-market accounting forces banks to mark their portfolios against indexes that aren't representative of what's going on in the markets at all,'' Bove said in a Feb. 28 interview.

One index banks use ``shows something like an 8 percent potential loss in commercial real estate in the United States,'' he said. ``Do you know what the actual loss is right now? One quarter of 1 percent.''

`Fallacious Indexes'

In other words, banks are marking their securities against an index that suggests the losses will be 32 times worse than the actual loss experience, Bove said.

``We're marking against fallacious indexes,'' he said, ``and that's creating more problems than necessary.''

A key issue is that with many investors shunning risk, an asset that in the future might have substantial value may have few if any buyers now.

One of the reasons for having a mark-to-market requirement was to prevent institutions from carrying an asset at its purchasing price more or less indefinitely when its current value was lower.

Still, does it really make sense to mark-to-market in the midst of such financial turmoil? Many subprime-related assets are worth much less than par, though some analysts seem to take delight in inflating the potential losses on them, as I wrote in an earlier column.

Grace Period

Bernanke was responding to a question from Senator Charles Schumer, a New York Democrat, who said he had heard ``from many people'' that the valuations have been ``artificially low.'' That leads to a vicious cycle, he said, in which the writedowns sap bank capital and ``they can't do any more lending and everything's frozen up.''

Schumer suggested one response might be to have a six-month grace period on mark-to-market.

``You really don't know the value of the asset, and if you undervalue it, you may be hurting things as much as if you overvalue it.''

Bernanke didn't buy that idea.

``The risk on the other side is that if you do too much forbearance or delay mark-to-market, the suspicion will arise among investors that you're hiding something,'' he said, adding, ``This is really an accounting board responsibility.''

In one important regard, Schumer's premise also exaggerated the problem.

Even with all the writedowns and other types of losses, the vast majority of U.S. banks are still well capitalized.

99 Percent

The Federal Deposit Insurance Corp. said in its Quarterly Banking Profile released Feb. 26, that at year-end 99 percent of all insured institutions, representing more than 99 percent of the nation's banking assets, met or exceeded the highest regulatory capital standards.

Yes, the fourth quarter was terrible for the industry. It registered a $10.6 billion trading loss, the first such quarterly loss in history, and total net income fell to $5.8 billion, the lowest for a fourth quarter since 1991.

On the other hand, even with the writedowns, total banking assets increased $332 billion, or 2.6 percent, and domestic deposits rose by $171 billion, or 2.5 percent, the largest quarterly increase in history.

As Bernanke also said in his testimony, there probably will be some small banks failures this year. There were three that did so in 2007, and their passing caused no major ripples.

Perhaps if a broad swath of investors came to understand just how strong the banks are even with the massive writedowns, maybe some of the fear stalking the markets would abate.

(John M. Berry is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: John M. Berry in Washington at jberry5@bloomberg.net

Last Updated: March 4, 2008 00:06 EST