The Paradox of Today's Financial Regulation

The FDIC has been monitoring the capital ratios of banks for decades to make sure they are appropriately capitalized. If they are "well-capitalized," then banks should feel good about themselves, right? Unfortunately, the mark-to-market rules have rendered the long-used FDIC capital ratios completely useless. As banking analyst Gary Townsend points out, depending upon whether a security is classified as a "loan" or an "investment" makes a significant difference for accounting purposes.

Look again at the example of The Bank of New York Mellon, which in the fourth quarter wrote down the value of its $5 billion Alt-A MBS portfolio by $1.24 billion, roughly a 25% mark to market. In its disclosures, the company noted that if that same asset were given loan accounting treatment (and what is a MBS but a collection of mortgage loans, after all?), its expected loss, based on estimated cash flows, would have been only $208 million, a mark of just 4.1%. The difference between the two accounting results: more than $1 billion.

Further, Townsend notes that mark-to-market is creating a ton of confusion out there and uses Capital One as an example:

Consistent with GAAP, Capital One reported a year-end tangible book value per share of $28.24, a substantial tangible common equity to tangible assets ratio of 5.57%, and a Tier 1 risk-based capital ratio of 13.6%, much more than well-capitalized for regulatory purposes. But subtract intangibles and the $12 billion in mark-to-market adjustments to assets and liabilities, and the company is insolvent. Obviously, no company can be well-capitalized and insolvent simultaneously, but is it any wonder that the market is so confused, that regulatory capital ratios are no longer credible, and that Capital One’s stock trades at $12.05, 43% of reported tangible book?

There are several things the government could do to help ease the financial crisis and mark-to-market changes wouldn't cost a dime. The existing rules just add too much uncertainty.