I have been posting so much bad news over the last couple of years that I thought it would be interesting to try something different for a change: look for something that's truly good. If I can find it, I'll tell you what the good news is, why it's important, and what it means for the rest of the world.
The SEC has a big share of the responsibility for the financial catastrophe greeting our 44th president. For example, in 2004 it passed a ruling which allowed financial institutions (FIs) to borrow as much money as they wanted -- which leveraged them up to $30 of debt for every dollar of capital -- and it repeatedly missed opportunities to shut down Bernie Madoff's $50 billion Ponzi scheme.
So it may come as a surprise to note that the SEC has done something right. What's that? It elected to keep an accounting rule that the banking industry was trying to get repealed. It is called mark-to-market and it requires FIs to adjust the value of their assets to reflect those assets' current market value even if they plan to hold them for years. (Ironically, mark-to-market meant the opposite to Enron which used a rule with the same name to record as current revenues potential gains it might make in energy trades 20 years in the future.)
The SEC's decision is good news because it means that investors will continue to get a truer picture of an FI's true net worth than they would have if the FIs had gotten their way and market-to-market was repealed.
Unfortunately, this is not a clear cut issue. That's because most of the assets in question are Level 3 assets -- like the $13 trillion worth of Collateralized Debt Obligations (CDOs) and Mortgage-Backed Securities (MBS) -- which have no real market value since virtually nobody wants to buy them at the moment. This means that FIs must mark them to market at the very low levels of the occasional transaction -- such as Merrill Lynch's sale of $30.6 billion worth of such assets for 22 cents on the dollar in July 2008.
If mark-to-market didn't exist, the FIs would be able to report that those devalued assets were worth 100 cents on the dollar until they matured. And this would go a long way towards relieving the financial crisis since so much of the $1 trillion worth of FI write-downs over the last year are due to that toxic waste. Unfortunately, the SEC decided not to cave into the interests of the FIs way too late to protect investors.
Nevertheless, the SEC deserves to be congratulated for doing the right thing today.
Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter.
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