No one is immune to the ripple effect of the current economic downturn. While community banks may not have caused the current liquidity problem — and everyone from the American Bankers Association, the Independent Community Bankers Association and even Fed Chairman Ben Bernanke himself will admit that — just like consumers they are feeling its effects.
Besides finding it more difficult to obtain capital, community banks are feeling a crunch caused by the conservatorship of Fannie Mae and Freddie Mac. Many community banks hold preferred shares of Fannie and Freddie. Once the government-sponsored entities were placed into conservatorship by the Treasury and the Housing Finance Agency, the GSE’s stock prices plunged and those shares became virtually worthless.
Because of mark-to-market accounting, a product of the Sarbanes-Oxley Act of 2002, banks must write the worthless preferred shares off as a cash loss. Some believe this is undermining the flow of lending between banks and is partly, if not mostly, to blame for the current liquidity crisis.
On one side, you have Newt Gingrich, who in an article on Forbes.com said, “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.”
On the other side you have the president of the Financial Accounting Foundation, Robert Denham, in a letter to House Financial Services Committee Chairman Barney Frank writing, “We believe that any legislative effort to overturn a FASB standard will greatly undermine investor confidence. We believe that once Congress starts setting accounting standards through the political process, the integrity of U.S. accounting standard setting and the credibility of U.S. financial reporting will be dangerously compromised.”
In the meantime, the Securities and Exchange Commission and the FASB have released revised guidance on how to apply fair value accounting to troubled assets and essentially are asking financial institutions to use sound judgment.
As the debate continues on whether fair value accounting should be temporarily discontinued until the current economic situation subsides, click on the links below to find articles and information relating to mark-to-market, the conservatorship of Fannie and Freddie, proponents’ opinions of mark-to-market and opponents’ reasoning for discontinuing mark-to-market.