In the 1990s, when I was a technology analyst on Wall Street, I often heard economists explain why Japan’s economy and stock market were mired in a lost decade.
Japan, the economists said, refused to acknowledge that its banks were insolvent. Japan was allowing the banks to continue to pretend that they were healthy–by not writing down bad loans and by making new loans so companies could pay interest on bad loans and the bankers could say that the bad loans were good loans. Until Japan forced its banks to write off bad loans and stop making new loans to pay interest on bad loans, the economists said, Japan’s economy would suffer.
The economists always said this as though it was the most obvious thing in the world. The Japanese were just wimpy socialists who lacked the balls to face up to reality.
And now so are we!
A few years ago, the U.S. put an accounting rule in place that was designed to help us avoid becoming Japan: mark-to-market. Since the market is the best judge of the value of any security (better than the average individual, always), mark-to-market makes it harder for banks to lie to themselves and the rest of us about what their loans are worth.
Banks loved mark-to-market when markets were going up, because they no longer had to defend the high prices they placed on their assets. They could just mark them to the market price, watch billions of dollars of profits flow through to the bottom line, and cash in at the end of the year.
Now that markets are going down, however, banks are screaming bloody murder about mark-to-market, because it is making them insolvent. Banks don’t like being insolvent (who would?), so they have been kicking and screaming about how mark-to-market should be eliminated.
(Of course, the banks aren’t stupid, so they don’t say that mark-to-market should be eliminated because it is putting them out of business. They say it should be eliminated because, this time, the market is wrong: It’s not that so many loans are going to go bad. It’s that we are having a little liquidity crisis. The moment we fix the liquidity crisis, prices will go back up.)
Banks employ lots of people (voters) and give lots of money to politicians. So, naturally, when banks screamed about the horrific unfairness of mark-to-market, politicians listened. And began screaming, too. And so did investors, who kept losing their shirts.
And with the politicians and bankers and investors all screaming and losing their shirts, the folks who work at FASB (the people who establish accounting rules) suddenly began to feel a little less popular at cocktail parties. No longer were they the folks who had figured out how to help our banks and investors and politicians get rich in the boom years. Now, they were the folks who were putting our banks out of business, costing investors their shirts and employees and politicians their jobs. All in the name of some silly little accounting rule that no one understands.
So FASB caved. And changed mark-to-market.
So now banks can go back to saying their assets are worth whatever they want them to be worth again. And we can pretend that bad loans are good loans and make more bad loans to help keep other good loans from going bad (would you like a new loan to pay the interest on that old loan?) and investors won’t get wiped out and employees and politicians won’t get fired and everything can be hunky dory.
Just like in Japan.