How Mark-to-Model Rules Are Killing The Government's Plan to Buy Banks Bad Assets

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Is the government putting off the day of reckoning?

The Wall Street Journal has a great story yesterday on how lobbyists pushed Congress to change the accounting rules. According to the WSJ, the financial services industry spent $27.6 million pushing lawmakers to help them relax the mark-to-market rules, which had forced banks and other financial firms to value bad assets at distressed prices. The rules have been at the center of huge losses at banks throughout the financial crisis. The lobbying paid off in the form of bigger profits in the past quarter and Wells Fargo, Citigroup, and other big banks. The whole story painted a pretty grim picture of what’s happening in Washington, as Felix Salmon notes in a recent blog post.

But the WSJ seems to miss the bigger picture, or at least a related issue. All of this lobbying was happening at the same time the government was setting up the Public-Private Investment Program or what’s affectionately known as PPIP. The two efforts fight each other. Banks don’t need to sell their bad assets if they can simply apply different accounting standards to the investments. By using mark-to-model accounting, they can increase the value of the assets. That way they’re no long a drag on the balance sheet—the whole reason the government set up PPIP in the first place. I don’t see how or why PPIP will ever work.

Of course, all this raises questions: If banks are holding on to their bad assets, does that mean there will be more trouble ahead? Or is it inhibiting their lending, thereby stifling the economy?

Either way, it’s probably not a good thing. If banks keep their bad assets and the economy continues to deteriorate, the investments may still sour (new accounting rules or not). When that happens, they’ll have to take more writedowns and losses. Even if the economy doesn’t get worse from here, the bad assets may be a drag on their books. Without those investments, the banks may be able to lend more freely. That, in turn, could help the economy recover.

All that makes me wonder why the government isn’t forcing them to get rid of their bad assets. Even if they’re not a drag on the banks’ books, they may be a drag on the economy.

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