If you are a dedicated reader of the financial papers you may have fallen for the line that mark-to-market accounting rules are a major contributor to the financial crisis. I caution you to examine that argument with a great deal of skepticism. Mark-to-market accounting rules did make things worse in the financial markets, but this ill-conceived rule was not the primary cause of the crisis.
Otherwise known as Federal Accounting Standard (FAS) 157, the mark-to-market accounting rule requires banks, securities firms and insurers to periodically reassess the value of their securities, portfolio or account, so that the most current and accurate value of these assets are reflected in a firm’s financial statements. Though this accounting standard has been used voluntarily or through SEC mandate for a number of years in different industries, it became more widely used when the FASB made the rule effective for all banks, securities firms and insurance entities with fiscal years beginning after November 15, 2007.
This rule has been blamed for causing an uncontrollable collapse in the markets throughout the past two years. Many claim that if the rule had been repealed earlier we would not have seen such chaos and panic in the markets. Steve Forbes is on record as saying that the SEC should have rescinded mark-to-market accounting rules immediately because they “force a bank to show the impairment on its balance sheet from a loss it hasn't taken yet.”
Renowned hedge fund manager, John Mauldin chimed in on the mark-to-market issue more than once over the past year in his weekly newsletter, “Thoughts from the Frontline”. In an issue entitled “The Law of Unintended Consequences”, from March 6, 2009, Mauldin quoted Gary Townsend, a former federal bank regulator:
The Financial Accounting Standards Board has said that it will issue new guidance on the application of FAS 157. That's encouraging, but can anyone recall when the FASB has been timely? The damage from this misguided rule is already huge, widespread, and growing daily. Mark-to-market accounting creates a powerful negative feedback loop. Actual or imputed FAS 157-related losses weaken capital ratios and undermine confidence in the financial system generally, which weakens the economy and adds pressure on loan pricing, causing more FAS 157 losses, and around we go. This cycle needs to be broken. Mary Schapiro? Tim Geithner? Are you listening?
The writers at The Wall Street Journal have also given the mark-to-market rule a great deal of blame for the banking crisis. In an article entitled “Congress Helped Banks Defang Key Rule”, printed on Wednesday June 3rd, 2009, a WSJ reporter boldly claimed: “The accounting issue lies at the heart of the financial crisis”.
The WSJ article and others that take on the mark-to-market accounting issue have given an overly simplistic explanation for the cause of this past year’s market turmoil. They place the blame on stringent accounting rules—forgetting the myriad of additional obnoxious government interventions that deserve to be condemned. It is easy to be led astray by simple arguments that entail reforming one regulation that could act as the magic bullet to bring the banking crisis to an end. Unfortunately, the problems with the banking sector cannot be summed up in a one-liner about a troublesome accounting rule.
Even if FAS 157 had been the root cause of the financial crisis, our regulatory overlords have done a pitiful job of taking corrective action. Of all the many regulatory agencies we have, who should we rely on to push through regulatory reforms in a timely manner? The Federal Accounting Standards Board (FASB)?
Don’t count on it. The FASB runs at a snail’s pace—just as all bloated bureaucratic organizations do. On February 18, FASB said it didn’t expect to complete its examination of mark-to-market accounting standards until late June. This was intolerably slow for Congress, so after intense hounding from legislators and lobbyists, the FASB rushed to make changes to FAS 157. The most recent update can be found in the “Proposed FASB Staff Position”, (FSP) FAS 157-e.
This sorry excuse for reform came on April 2, 2009, after a 15-day public comment period. FASB eased mark-to-market rules so that financial institutions are still required to mark financial assets to market prices but only in a steady market. When the market is “inactive” or too turbulent, the rules do not need to be followed.
The reform simply involves changing the rules so that banks need only follow FAS 157 rules during “normal market activity”. When markets are behaving abnormally, reporting entities are given the freedom to value their assets with their own in-house valuation models. Let’s think about this…what is the probability that a firm’s in-house models would give a more favorable valuation of the assets on its books than the market would? I’d say pretty high.
The FASB’s response is an abysmal excuse for regulatory reform. They are allowing reporting entities to ignore the rule when it is too painful to comply with and muddying the waters further by letting them use their own discretion when valuing assets on their books. Why not abolish the rule altogether instead of making its use conditional? Better yet, leave the rule intact. According to James Chanos, chairman of the Coalition of Private Investment Companies and founder and president of Kynikos Associates LP., “Obfuscating sound accounting rules by gutting MTM rules will only further reduce investors’ trust in the financial statements of all companies, causing private capital—desperately needed in securities markets—to become even scarcer. Worse, obfuscation will further erode confidence in the American economy, with dire consequences for the very financial institutions who are calling for MTM changes.”
The so-called reform of the mark-to-market accounting rule is regrettably not an improvement, to say the least—so much for the FASB being an effective regulatory authority. And where has the SEC been? Under the Securities Exchange Act of 1934, it was given statutory authority to establish financial accounting and reporting standards for publicly held companies. The SEC proved itself to be a lame duck on this issue. It was seemingly incapable of doing anything about FAS 157 before the FASB made its’ feeble attempt at reform.
What is also surprising is that you can’t find anything resembling a coherent argument on the FASB website about the FAS 157 controversy. Accountants frequently joke about how it is nearly impossible to find anything on the FASB website unless you know the exact title or code of the document that you are looking for. This is a real shame. People have been complaining about FAS 157 for more than a year now. You would think that the crisis would have inspired FASB to post highly visible, comprehensive discussions about mark-to-market reform on their website.
To make the FAS 157 issue even more confusing, there is still an ongoing debate about whether mark-to-market accounting should have become a required accounting rule in the first place. The debate was not even close to being settled when FAS 157 was first issued in September 2006. Now we have a regulatory change that was rushed into because: “We had to do something!” How many bad cases of reform have we been given because of this pathetic argument?
Let me conclude by restating the message I wish to convey through this article—the bank’s balance sheets are in terrible shape—no one denies that. Is it due to the fact that banks have to mark their assets to current market prices? Or, is it due to the fact that, thanks to the unsound inflationary policies of the Fed, the banks were seriously overleveraged in the first place? I’m in the overleveraged camp.
This accounting rule is indeed making the situation worse, but it is not the cause of the crisis. The cause is an overexpansion of money and credit by banks. The cure is a return to sound money and banking practices.
Betsy Hansen
Friday, August 14, 2009
Will radically different banking plans work?
Not until we abolish legal tender laws.
Until we abolish legal tender laws, all attempts on the part of entrepreneurs to set up gold and silver banking institutions will be labeled as “a tax evasion scheme to hide income”.
If you don’t believe me, ask Franklin Sanders. He is a man who knows first-hand, that when you try to question the government’s role in our monetary affairs, you don’t have a chance. How can one man win in a battle for economic freedom against the government, when the government has vast monetary resources through its control of the printing press and armed attack squads that can use brute force against anyone who challenges government decrees?
Mr. Sanders fought gallantly given the impossible circumstances in which he found himself. He ran a gold and silver bank for more than a decade, serving customers in Mississippi, Arkansas and Tennessee. His hope was to run his business as a truly free bank, such that he would exchange federal reserve notes for gold and silver—and here is the kicker—he tried to do that without charging sales tax on the exchanges. It is true, what Mr. Sanders was doing was entrepreneurial suicide, but you have to give him credit for showing courage and tenacity.
In 1980, he opened his doors for the first time, selling physical gold and silver. According to his fascinating autobiographical essay, available on his website: www.the-moneychanger.com, he did his best to cover his bases with the local authorities:
First thing I did was, write to the Arkansas Attorney General to explain that I thought exchanges of gold and silver money for paper money weren’t subject to the sales tax, since they were exchanges of money for money.
Even though no one chose to respond to him, he continued to contact local political officials to confirm that his business was not violating state law. He even wrote to the Commissioner of Revenue to inform him of what he was doing— to no avail. He never got a response from anyone, at least not until Revenue officers and IRS criminal Investigation Division (CID) agents came to harass him.
During the time he was left alone, his bank did very well. He attracted depositors from all over. The government brought a swift end to his business, however. First, they forced him to move to another state, and then, they scared all of his customers away by requiring that they send records of their exchanges with him to IRS CID agents, threatening to issue subpoenas to whoever refused to comply. After his first dramatic escape from IRS hounds, Sanders opened his doors in another state:
I moved my business to Tennessee, doing the same thing, exchanging gold and silver money for Federal Reserve notes. By this time I had realized that although every American had a constitutional and legal right to gold and silver money, the problem was, you couldn’t use them in everyday business. We had the right to sound money, but no means. We needed an interface between the paper system and gold and silver. So in May, 1984 I opened a gold and silver bank. I attracted depositors like wildfire, but somebody didn’t like my idea.
After years of harassment, Sanders was eventually arrested. As Murray Rothbard repeatedly reminds us, the government reviles anyone that challenges its’ monetary monopoly. The harsh treatment of Sanders illustrates this point. “My bond was set at $150,000, fully secured. For comparison, that same day they arrested a child molester and set his bond at $10,000, not secured.” A powerful quote that accounts for Sanders’ treatment came directly from the agents of the government: “The assistant US attorney here told one lawyer that I was ‘the most dangerous man in the mid-South.’ In a four and a half year investigation the government spent $5-$10 million, maybe more.”
According to Sanders, the government was desperate to claim that he was the mastermind behind a cluster of illicit activities. Foremost among them was “delaying and depriving the state of revenue to which it was lawfully entitled at the time it was lawfully entitled thereto.” The government’s inch thick indictment claimed that a total of 26 people, with Franklin Sanders at the helm, were part of a “conspiracy to defraud the government, willful failure to file, and divers other malefactions. The government claimed that the gold and silver bank was a tax evasion scheme to hide income.”
Sanders tried to use the law in his defense, but his points went unanswered. “On the money issue, the real heart of the case, the court dodged and denied all my arguments.” They obviously had no historical or theoretical background that would open their eyes to the truth of his arguments. If Austrian-Libertarian leaning individuals heard his arguments they would cheer in approval. Take this statement, for example, in which he brilliantly states what Austrian economists have been trying to convey to the public for decades:
They were charging me with not collecting sales tax on exchanges of gold and silver money for paper money. You know—like when you go to the bank, and give the teller a twenty and she gives you back a ten and two fives, less sales tax. What? She doesn’t charge you with sales tax? Of course not, because it’s an exchange of money for money.
He attempted to battle in court for his right to exchange what he considered to be “money for money”. Yet, he was trying to fight a legal battle in “Legal Never-Neverland: monetary law.” In his fiercely direct style, he explains the dilemma that anyone faces when they try to argue with the government over monetary freedom.
neither the state of Tennessee nor any other state can admit that gold and silver coins are money. If they do, they will admit they are operating outside the law. The monetary emperor is naked, and state officials from the Chief Justice of the Supreme Court to the governor to the second assistant tire checker are afraid to tell him. They should be afraid, because the monopoly on money creation is the jugular vein of the American fascist state.
He understands how dangerous and perverse the government’s control over our monetary system is. He tried to battle the government with the best legal arguments he could muster, but since the government’s legal bureaucrats would never address the money issue, he lost his case, after fighting a legal battle that lasted for 15 years. That takes fortitude! To those who would question his sanity for pursuing an obviously unwinnable legal battle, he says:
Why keep on fighting? After 15 years, why not just put down the load and forget it? Because the fiat money system is both the strength and weakness of America’s tyrants. It bleeds the people’s wealth and labor, but it also threatens to collapse under its own weight—or whenever the scales fall off the people’s eyes. With its green engravings of famous Americans, electrons whirling around in bank computers, and loans created out of thin air, it is one vast confidence game.
Franklin Sanders’ story reminds us that the future of private enterprise in money has no chance until we abolish legal tender laws, and remove all forms of taxes on commodity money. This type of change will require a political revolution. Unless we witness a mass political movement demanding monetary freedom, I do not see any way forward for a market driven substitute to the government’s monopoly over money. We have to gather and inspire enough political will to abolish legal tender laws and all taxes on commodity money.
Until we abolish legal tender laws, all attempts on the part of entrepreneurs to set up gold and silver banking institutions will be labeled as “a tax evasion scheme to hide income”.
If you don’t believe me, ask Franklin Sanders. He is a man who knows first-hand, that when you try to question the government’s role in our monetary affairs, you don’t have a chance. How can one man win in a battle for economic freedom against the government, when the government has vast monetary resources through its control of the printing press and armed attack squads that can use brute force against anyone who challenges government decrees?
Mr. Sanders fought gallantly given the impossible circumstances in which he found himself. He ran a gold and silver bank for more than a decade, serving customers in Mississippi, Arkansas and Tennessee. His hope was to run his business as a truly free bank, such that he would exchange federal reserve notes for gold and silver—and here is the kicker—he tried to do that without charging sales tax on the exchanges. It is true, what Mr. Sanders was doing was entrepreneurial suicide, but you have to give him credit for showing courage and tenacity.
In 1980, he opened his doors for the first time, selling physical gold and silver. According to his fascinating autobiographical essay, available on his website: www.the-moneychanger.com, he did his best to cover his bases with the local authorities:
First thing I did was, write to the Arkansas Attorney General to explain that I thought exchanges of gold and silver money for paper money weren’t subject to the sales tax, since they were exchanges of money for money.
Even though no one chose to respond to him, he continued to contact local political officials to confirm that his business was not violating state law. He even wrote to the Commissioner of Revenue to inform him of what he was doing— to no avail. He never got a response from anyone, at least not until Revenue officers and IRS criminal Investigation Division (CID) agents came to harass him.
During the time he was left alone, his bank did very well. He attracted depositors from all over. The government brought a swift end to his business, however. First, they forced him to move to another state, and then, they scared all of his customers away by requiring that they send records of their exchanges with him to IRS CID agents, threatening to issue subpoenas to whoever refused to comply. After his first dramatic escape from IRS hounds, Sanders opened his doors in another state:
I moved my business to Tennessee, doing the same thing, exchanging gold and silver money for Federal Reserve notes. By this time I had realized that although every American had a constitutional and legal right to gold and silver money, the problem was, you couldn’t use them in everyday business. We had the right to sound money, but no means. We needed an interface between the paper system and gold and silver. So in May, 1984 I opened a gold and silver bank. I attracted depositors like wildfire, but somebody didn’t like my idea.
After years of harassment, Sanders was eventually arrested. As Murray Rothbard repeatedly reminds us, the government reviles anyone that challenges its’ monetary monopoly. The harsh treatment of Sanders illustrates this point. “My bond was set at $150,000, fully secured. For comparison, that same day they arrested a child molester and set his bond at $10,000, not secured.” A powerful quote that accounts for Sanders’ treatment came directly from the agents of the government: “The assistant US attorney here told one lawyer that I was ‘the most dangerous man in the mid-South.’ In a four and a half year investigation the government spent $5-$10 million, maybe more.”
According to Sanders, the government was desperate to claim that he was the mastermind behind a cluster of illicit activities. Foremost among them was “delaying and depriving the state of revenue to which it was lawfully entitled at the time it was lawfully entitled thereto.” The government’s inch thick indictment claimed that a total of 26 people, with Franklin Sanders at the helm, were part of a “conspiracy to defraud the government, willful failure to file, and divers other malefactions. The government claimed that the gold and silver bank was a tax evasion scheme to hide income.”
Sanders tried to use the law in his defense, but his points went unanswered. “On the money issue, the real heart of the case, the court dodged and denied all my arguments.” They obviously had no historical or theoretical background that would open their eyes to the truth of his arguments. If Austrian-Libertarian leaning individuals heard his arguments they would cheer in approval. Take this statement, for example, in which he brilliantly states what Austrian economists have been trying to convey to the public for decades:
They were charging me with not collecting sales tax on exchanges of gold and silver money for paper money. You know—like when you go to the bank, and give the teller a twenty and she gives you back a ten and two fives, less sales tax. What? She doesn’t charge you with sales tax? Of course not, because it’s an exchange of money for money.
He attempted to battle in court for his right to exchange what he considered to be “money for money”. Yet, he was trying to fight a legal battle in “Legal Never-Neverland: monetary law.” In his fiercely direct style, he explains the dilemma that anyone faces when they try to argue with the government over monetary freedom.
neither the state of Tennessee nor any other state can admit that gold and silver coins are money. If they do, they will admit they are operating outside the law. The monetary emperor is naked, and state officials from the Chief Justice of the Supreme Court to the governor to the second assistant tire checker are afraid to tell him. They should be afraid, because the monopoly on money creation is the jugular vein of the American fascist state.
He understands how dangerous and perverse the government’s control over our monetary system is. He tried to battle the government with the best legal arguments he could muster, but since the government’s legal bureaucrats would never address the money issue, he lost his case, after fighting a legal battle that lasted for 15 years. That takes fortitude! To those who would question his sanity for pursuing an obviously unwinnable legal battle, he says:
Why keep on fighting? After 15 years, why not just put down the load and forget it? Because the fiat money system is both the strength and weakness of America’s tyrants. It bleeds the people’s wealth and labor, but it also threatens to collapse under its own weight—or whenever the scales fall off the people’s eyes. With its green engravings of famous Americans, electrons whirling around in bank computers, and loans created out of thin air, it is one vast confidence game.
Franklin Sanders’ story reminds us that the future of private enterprise in money has no chance until we abolish legal tender laws, and remove all forms of taxes on commodity money. This type of change will require a political revolution. Unless we witness a mass political movement demanding monetary freedom, I do not see any way forward for a market driven substitute to the government’s monopoly over money. We have to gather and inspire enough political will to abolish legal tender laws and all taxes on commodity money.
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