by Jennifer Baty
Conservatives are quick to point to the impact of the Community Reinvestment Act on this economic mess we're in, but perhaps the changes to accounting methods mandated by the Sarbanes-Oxley Act of 2002 (SOX) may be more to blame. Newt Gingrich in his recent commentary opined on the impact of "fair value" accounting required by SOX on the implosion in the financial sector:
Mark-to-market accounting (also known as "fair value" accounting) means that companies must value the assets on their balance sheets based on the latest market indicators of the price that those assets could be sold for immediately. Under such a rule, declining housing prices don't just reduce the value of defaulting mortgages. They reduce the value of all mortgages and all mortgage-related securities because the housing collateral protecting them is worth less.
Moreover, when a company in financial distress begins fire sales of its assets to raise capital to meet regulatory requirements, the market-bottom prices it sells out for become the new standard for the valuation of all similar securities held by other companies under mark-to-market. This has begun a downward death spiral for financial companies large and small.
Will SOX reforms be included in the next "bailout" bill? While we certainly want to keep accounting methods transparent and ethical, we should not hang on to methods that actually cause devaluation, setting up investors and markets for dramatic losses. Reform and/or elimination of market-to-market accounting methods makes good sense, and using a three-year rolling average for valuation seems a reasonable compromise.
Let's hope that Washington will take the time to craft a bill that is comprehensive enough to include such reforms, rather than rush through another one that will only put a band-aid on deep, festering wounds which ask the taxpayers for more of what we don't have.
- Jennifer Baty
