What Reversed the Market in the Spring of 2009? Hint: It wasn’t QE.

On April 2, 2009 the Financial Accounting Standards Board, under intense pressure from both Congress and the US banking industry, suspended FASB 157; otherwise known as mark-to-market.   According to an article from Bloomberg on that day, the ruling would “allow companies to use ‘significant’ judgment in gauging prices of some investments on their books, including mortgage backed securities.”

Prior to this relaxation in the valuation rules, banks had to mark their assets to their current market value – something that created a crisis-induced feedback loop in MBS as margin calls forced banks to dump MBS which dropped their market value which caused more margin calls, which…   well, you get the idea.

So, Congress, Citigroup, the American Bankers Association, Blackstone Group, and the FDIC all got together to suspend FASB 157 so that banks could value their near-worthless MBS at something higher than near-worthless.

Here are a few of the quotes from that fateful, market reversing day:

Robert Rubin (former Citigroup senior counselor and Treasury Secretary):   “The rule (FASB 157) has done a great deal of damage.”

Spencer Bachus (House Financial Services Committee):   “Financial institutions and community banks have been adversely affected by the rigid application of these rules during this financial crisis, causing further instability in the banking system.”

Brian Wesbury (First Trust Advisors):   “It will put the banks back to where they would have been if the rule hadn’t been in place.   The biggest remaining question is whether the auditors will agree with the judgment of the bank management.”

William Issac (chairman of the FDIC):   “Fair value is a major cause of the credit crisis.”

Upon the news of 157’s suspension, Citigroup’s stock rallied 2.2%, Bank of America rallied 2.7%, and the KBW Bank Index rose 6.1%.

See.   Problem solved.   Using fair value is for chumps.

What seems perverse to me (much like seasonal adjustments, but don’t get me started on that), is that we improved bank earnings and stock prices by saying, “let’s not use the real number to value the holdings.   That’s way too harsh.   Let’s let the banks with the toxic assets tell us what they think the assets are worth and we’ll judge their stability based on that metric.”

And Richard Parsons approved.   As did Stephen Schwarzman.

When it was all said and done, Quantitative Easing did little to rescue the financial markets aside from causing massive mal-investment.  What turned the tide for an imploding global financial system was something so much simpler — changing the rules from “mark-to-market” to “mark-to-unicorn.”

That unicorn of ours has been getting quite the workout over the past five years.   I’d send him a new abacus, but I don’t know the zip code for Xanadu.   I guess he’ll have to make due.

– LL

unicorn