Last week Federal Reserve Chairman Ben Bernanke said:
…commercial real estate loans should not be marked down because the collateral value has declined. It depends on the income from the property, not the collateral value.
Why he didn’t come out and say this in 2008 will always be a mystery. If he had said it then, the world and particularly the US might have avoided this financial crisis.
In November 2007, FASB (Financial Accounting Standards Board) reinstated mark-to-market accounting for the first time since 1938. This rule uses the last price of a similar asset sale to value assets. This caused the market for asset-backed securities to dry up. The prices of bonds and mortgages that were still current in their payments fell by 1/3 to 1/2. In a roundabout way, this had the effect of wiping out regulatory capital, causing bankruptcies and creating a vicious downward spiral in the economy.
Last April, FASB told banks they could use asset cash flow to value bonds and mortgages. This fixed the immediate problems in the system, and the economy and financial markets have been on a tear since.
However, now we read that bank regulators are enforcing their own version of mark-to-market accounting by using the appraisal process. Regulators are forcing banks to write down loan values and increase loan-loss reserves by using appraiser-driven valuations. Appraisers? Aren’t they the same people that over-valued properties five years ago?
To the bank regulators, it does not matter if the loan is still being paid on time. Additionally, it does not matter to them if the lower valuation of the collateral will make the bank require that the borrower put up additional cash. The result is decreased bank lending that is hurting small business and making it more difficult to reduce unemployment, which is not necessary. Most banks are well capitalized today, better in fact than they were in the 1980s when banking losses were very high. In the 1980s we did not have mark-to-market rules, so if a loan was being paid on time, the bank did not have to set aside much in the way of reserves for it.
We need bank regulators to get on the same page with the Chairman of the Federal Reserve.
Post written by David Hess, Executive Vice President and Managing Broker
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