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Washington's 'fuzzy math' and the next Depression

Posted By Dan Mangru On 06/24/2010 @ 12:50 am In Commentary,Money | Comments Disabled

Once fodder for a presidential campaign, the term “fuzzy math” really puts Washington, D.C., standards of budgeting and accounting into perspective.

I mean how else could Obama & Company demand $200 million more to spend in a new stimulus when they still have $377 billion left to spend from their $787 billion porkulus program.

What the administration says to justify the additional $200 million is that the U.S. economy has not fallen into utter oblivion; hence the stimulus must be working.

There’s no concrete way to prove them wrong, meaning we don’t know what would have happened to the U.S. economy if we did not have the stimulus. There’s also no concrete way to prove them right, meaning that you cannot determine with certainty that the stimulus was the deciding factor in helping the U.S. economy avoid disaster.

The best word to describe this type of math and logic is “fuzzy.”

Well, our pals in Washington are at it again, with a new accounting fine print that could send the economy into tailspin.

Back in November of 2007, or as you and I know it, the height of the stock market, the Financial Accounting Standards Board decided to enact a little rule known as mark-to-market.

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Here’s a good example of what mark-to-market accounting is:

You own a stock at $5 per share. The stock then rises to $10 per share. If you had 100 shares of stock your book value (what you bought it for) is $500, and your mark-to-market value (what it is worth) would be $1,000.

While valuing assets at mark-to-market might make more sense, consider the following scenario.

Banks have incredible amounts of real-estate assets and notes that keep on going up in value. While their book value (what they bought it for) might be $100,000 per unit, the mark-to-market value (what it’s worth) might be $200,000 per unit.

Now if the price of those homes goes from $200,000 back to $100,000, under mark-to-market accounting the bank has to show a $100,000 loss, even though it technically hasn’t lost any money.

When investors see that banks are losing money they start selling shares. Hence, under this scenario, even though the bank has not lost a single penny (i.e., the house is worth exactly as much as they paid for it), banks would be forced to report losses that really don’t exist.

If all companies had to do this, we could be looking at the next global selloff.

Case in point, regional and community banks that are currently holding loans on commercial property would be devastated. Even though many commercial properties are paying back their loans as agreed, the SEC or FASB could step in and say that because the commercial-property markets have declined over the past two years the value of the commercial property is no longer the value of the mortgage and that the bank must take a loss on the commercial property, even though the bank is not losing money and even though it is receiving all of its payments on time.

Not only does this expose banks to potentially huge losses that don’t exist, but it creates new jobs and fees for regulators and auditors who will be responsible for determining what is “fair value” for all of the assets held within a publicly traded company.

I’m not the only one who is pointing this out.

Back in April, when I interviewed Bert Dohmen for The Mangru Report on Fox Business Network, Bert warned that there was a quiet movement to bring mark-to-market accounting back.

Bert also pointed out correctly that when mark-to-market was repealed in March of 2009, the market rallied tremendously and started our current bull run.

Also Steve Forbes, who will be joining me at Freedom Fest in Las Vegas this July 8-10, recently wrote in his magazine that bringing back mark-to-market would be a “catastrophic change” for U.S. financial markets.

“With a pre-Depression-era mentality of businessmen who thought protectionism would make them richer by stifling foreign competition, many auditors today are salivating at the fees they’ll collect from the mammoth, laborious procedures necessary to evaluate millions of individual loans,” writes Forbes.

What we are looking at here is Washington fuzzy math at its finest. Instead of just booking items at the amount for which they were bought, we must create a complex system with more regulators and auditors to subjectively determine what things theoretically are worth.

The reason why I say theoretical is that, truth be told, you don’t know something’s true value until you sell it.

Mark-to-market has the makings of another recession written all over it. All of a sudden you have brand-new accounting rules and everyone has to start writing down the value of their assets regardless of whether they are performing or not.

It gets us into some very murky waters. But then again, our administration is never one to let a serious crisis go to waste (Rahm Emanuel’s words, not mine).

These fancy accounting rules could allow larger banks such as JPMorgan Chase and Goldman Sachs to start acquiring regional and community banks for pennies on the dollar.

You remember Goldman Sachs, the bank that received billions from the government via things such as the AIG bailout and other bailout payments. It’s quite interesting that all of the major institutions that owed money to Goldman Sachs were all bailed out, and all payments to Goldman Sachs were made on time and in full. That’s amazing!!!

When you connect all the dots, it’s very easy to conclude that there is a consolidation of power that is occurring.

Big banks are getting richer through the policies that are being enacted by an administration that they gave millions to during the campaign. Wall Street has made most of its money back but Main Street is still hurting big-time.

For example, since 2008 243 banks have failed or gone bankrupt in the United States. Among those banks, none of them were named Citigroup, Bank of America or Goldman Sachs.

But who cares about Main Street or small community banks?

I do and you should.

What people don’t realize is that small community banks create jobs for the people who work in the banks. Community banks are usually the ones who make loans to small businesses. Small businesses create even more jobs.

Small businesses then pay back their loans to the community banks, which allows them to lend to even more small businesses. When that happens we all win.

When more Americans are at working and adding to economic productivity of our country, everything is better. Stock prices go higher; businesses have more customers; Americans have more money.

I’ve always been a fan of keeping things simple. In science class we were always taught to look for the simplest answer, because usually that’s the best one.

If only they taught that in government class, we might not have had the first recession.

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