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The first thing to understand is that the world is not neatly divided into “mark-to-market” accounting and some single other form. The broad concept is “fair value” accounting; assets subject to this treatment must be valued at the price they would receive in an arms-length market transaction. Fair value accounting may apply to assets that are not traded on visible, liquid markets (like exchange-traded stocks), so in itself in can involve estimates. And there are a number of alternatives to fair value accounting, of which the most familiar is probably historical cost accounting (assets are carried on the balance sheet at whatever you paid for them).

 

Companies have a fair amount of latitude in deciding how they account for different assets. In some cases, the accounting treatment depends not on the nature of the asset itself, but on what the institution plans to do with it. for example, the same security can be designated as part of a trading account, available for sale (AFS), or to be held to maturity (HTM). Trading assets are accounted for at fair value, and changes in their value affect the income statement (profits and losses) directly; AFS assets are accounted for a fair value, but changes in value do not show up on the income statement (only in a line of adjustments to equity, and these adjustments to equity do not affect regulatory capital requirements); and HTM assets are not accounted for at fair value. In addition, there are also assets that only become subject to fair value accounting if they are subject to other-than-temporary impairment (OTTI); the idea here is precisely to ignore short-term fluctuations, but only write them down if they lose long-term value.

 

In short, the system is already designed to protect financial institutions from having to take writedowns in their asset portfolios due to short-term market movements, which is what fair value accounting stands accused of.

The first thing to note is that a majority of financial institution assets (55%) are not accounted for at fair value, and only half of those that are at fair value are of the type that affect the income statement (and therefore regulatory capital).

 

The second thing to note is that changes in fair-value assets during the first three quarters of 2008 were relatively small as a percentage of overall equity. Across a broad sample of the financial industry:

First of all, FASB’s existing accounting guidelines give companies considerable flexibility in avoiding so-called fair-value accounting, of which mark-to-market valuation is a subset. Fair-value accounting rules expressly state that illiquid or distressed transactions, such as are now occurring, cannot be the basis for mark-to-market valuation. Under FASB’s guidelines, financial institutions can reclassify many of their troubled assets in ways that allow them to avoid the use of fair-value accounting. That’s why it is difficult to understand the claim that mark-to-market accounting is driving this credit crisis.

 

In fact, the attack on fair-value accounting may be best understood as an attempt to resolve the furious debate over an issue known as regulatory forbearance, wherein regulators allow embattled banks to delay recognizing their losses in the hope that over time they can raise enough capital to offset the eventual recognition of those losses. By recasting this issue as one of overly burdensome accounting, proponents of regulatory forbearance can achieve their desired result without having to convince regulators of the merits of their position.

One of the key elements of GAAP, and the crux of the fair-value accounting debate, is how to properly value a company’s assets and liabilities. Based on the nature of an asset, GAAP prescribes different methods for recording its value. Generally, nonfinancial assets such as buildings and equipment are valued based on what was paid for them (less depreciation). Financial assets such as stocks, bonds, or derivatives are valued based on what would be received for them today. Sometimes this process is as simple as obtaining a market quote for the price of a share of stock, but sometimes it requires substantial judgment in estimating the present value of discounted future cash flows from the assets. As a general rule, GAAP aims to ensure that investors receive a fair and accurate assessment of a company’s assets and liabilities, while acknowledging that sometimes this requires estimates to be made.

The feds don’t even do the requirements directly -- in the federal highway program they reference the AASHTO Green Book. These are rules, they're just not stated as rules… On the interstate system you can’t have a lane that’s less than 12 feet wide, so that actually is a rule there. You have all these metrics that make everything bigger -- turning radii and ramps, the length of ramps -- all these things designed to have the vehicles move faster without having to slow down when they get off the freeway, that sort of thing.

So what are the metrics? The metrics would be intersection density, block size -- you would reward intersection density. And the feds can do that, they can say that states could draw federal money and add to the density of a street network, creating more mobility that way.

 

  And the metric we use is 150 intersections per square mile, which wouldn’t just be like Manhattan or Philadelphia. In Wausau, Wisconsin, which is the home of the chairman of the House Appropriations Committee, Dave Obey, we counted 158 intersections per square mile. That’s counting alleys. You look at all these places that have high intersection density and they're very likely to be valuable settings for jobs and real estate, and they're also very good for distributing local traffic