Fast rise after FASB change

Good afternoon folks!

You may have heard that the Dow Jones Industrial Average closed above 8,000 today. This means that the DJIA has had its best 4 week run since the 1930s. So what was the catalyst today? The Financial Accounting Standards Board changed an obscure rule having to do with how investment assets are valued on financial institution balance sheets. Technically the change had to do with “mark to market” accounting. This accounting forces institutions to value the investments on their balance sheets so that they closely reflect market value. Not surprisingly, FASB, the superhero of accountants, is very specific about how this has to be done. But FASB relaxed its rules today. And why should that matter? It matters because financial institutions are required to maintain certain amounts of capital on their balance sheets to satisfy regulatory requirements.

But isn’t this just a change in the “paper” value of assets? And why should it make any friggin‘ difference? After all, what changed is the accounting, not the underlying economic value of the assets. Right? Nope. The reason that this was important is that real world negative consequences are tied to the value of these assets as recorded on financial institution balance sheets. Because of the tying in of consequence with “paper” values financial institutions have been under tremendous pressure in terms of their earnings and solvency. So FASB, under pressure from lawmakers and financial institutions relaxed its rules. And the stock markets bounced.

My own personal opinion is that this is not a welcome change. Those “mark to market” rules took nearly 20 years of effort to go into force as they were fought tooth and nail by financial institutions. However, those rules were designed to keep financial institutions honest and prevent them from fudging the value of their investments. In short, FASB was trying to prevent window dressing of bank earnings and values of bank assets. This was a good thing. The relaxation today grants financial institutions greater leeway in determining the value of their own assets. Now just imagine if you and I got leeway in valuing our houses at the time of appraisal, refinancing or sale? Ridiculous, right? The market determines the value of the house, not you and me. What incentive is there for a bank to record a lower value for the assets than they are currently listed at? The answer is: none. The banks have every incentive to value their assets higher. And hopefully by now after reading ze blog after these many months you all know that incentives do drive behavior.

By the way, the market being up did make me some dough, so I can’t be too strident in my complaints. Heck, now that I think about it, I am going to lobby FASB to let me value my portfolio as high as I want to. The only problem will be when I try and go sell my assets in the market. Then I’m in for a rude surprise.

Good while you can get it!

Jason