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Dealing With Toxic Assets Means A Variety Of Tactics Must Mesh

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The Associated Press

Published: March 28, 2009

NEW YORK - Two plans to attack the credit crisis are careening into each other.

The Obama administration is trying to reignite lending by enticing private lenders to buy the toxic assets that have been stuck on the balance sheets of banks.

But the plan could be undercut by another initiative: relaxing accounting rules that determine how the assets are valued. That might boost the prices of those assets, making it harder to sell them.

"Imagine if we do all this and nothing changes for the better and the banks still don't lend," said Roger Ehrenberg, who runs his own investment firm and writes a blog called Information Arbitrage.

For months, the government has struggled with how to deal with mortgage loans gone bad and other risky securities. The market for such assets has collapsed, which means the banks can't sell them to investors.

At the same time, financial companies are required under the mark-to-market accounting rules to adjust the assets' values to reflect market conditions. In other words, a pool of residential mortgages that a year ago was worth $100 million might today be worth $50 million. The bank holding that pool must reflect the loss on its books, even if it's just a paper loss.

That's one big reason banks have taken massive writedowns the past two years. Those writedowns, in turn, have put a strain on their capital - the measure of how much money is on hand. Because banks are required to have certain minimum capital requirements, they have curbed lending to businesses and consumers to conserve their capital.

Now there is a glimmer of hope that a solution is on the way.

The goal of the Obama plan is to help create a market for unwanted securities. The first step is to place a value on them because few people are really sure what they're worth.

Unveiled Monday, the plan will take up to $100 billion from the government's $700 billion financial bailout pot. It then will pair that with private investments and loans from the Federal Deposit Insurance Corp. and the Federal Reserve to generate $500 billion in purchasing power.

Banks would unload troubled assets and securities to investors. Investors, in turn, hope to turn a profit.

Another plan to deal with toxic assets could negate the federal effort.

For months now, banks and their lobbyists have called on lawmakers and regulators to suspend the mark-to-market rules. They claim the rules force banks to report huge paper losses, even on assets they don't plan to sell. The losses are artificial, they say. This has exaggerated the crisis.

Supporters of mark-to-market argue that the rules provide investors a clear real-time picture of a company's finances. Without the rules, investors would not be able to measure the effect of the housing and credit collapse. Besides, if the value of the assets increases, the companies will take big gains in the future.

Changes look more likely. This month, lawmakers threatened to enact laws that would alter mark-to-market accounting if no quick fix came from the Financial Accounting Standards Board, which sets U.S. accounting rules.

On March 17, the FASB proposed changes that would give companies more leeway when valuing assets. One would allow for "significant judgment" on the part of bank managers to determine whether a market is not functioning. Executives then would have discretion over setting the value of the security.

The FASB is expected to decide on this version of mark-to-market as soon as Thursday. If it is approved, which many in the industry think is likely, companies could apply new valuation requirements in the current quarter, which for most companies will end in late April.

The fear is that companies will use this leeway to boost the value of the loans on their books to unrealistic levels, said Robert Willens, an expert on tax and accounting issues for Wall Street clients.

"The FASB's relaxation of these rules might come at the most inopportune time," he said.

In the short run, banks would benefit by raising the value of assets, but don't expect it to be a cure-all.

Higher values could drive private investors away. Investors don't want to overpay, even if they do have help from the government.

If that results in assets staying on banks' books, they may stay resistant to lending because they will worry about how such assets could perform in the future, Ehrenberg said.

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