A New, Mixed Regulatory Approach

While trolling through The Economist this week, I came across an article detailing potential next steps for those regulating the banking system. One section that stuck out to me was in regards to mark-to-market accounting rules for assets held on the balance sheets of financial institutions. While it may seem logical for financial institutions to value their assets at what they could be sold for on the open market, problems can arise when the bank has no intention of ever selling them. Many firms hold securities on their books as reserve assets since they have a greater return than simply holding cash - though there is added security.

Should the institution wish to hold such an asset, they must also value that asset at a 'market' price based on the value for which it could be sold. I do see a value in marking assets which are held for trading purposes at a mark-to-market value, but I think there must be a better way to base instruments meant to only be held on the balance sheet and never sold.

A hybrid solution to the accounting rules is a potential fix. For such an idea to work, the banks will be able to delineate some assets for 'trading' and others for 'holding'. Those assets held for trading would be treated according to the current mark-to-market rules. Their value would be determined on the open market and they would use existing tax regulations.

The difference in this model would be in the treatment of 'holding' assets. These securities would be placed on the balance sheet and have their values determined by a mark-to-model method. This would give the banks protection from declines in their values and the need to increase their reserves at inopportune times. The institution would be forced to declare which assets they would like to classify for this status. If the asset is held to maturity, it would be treated using the existing tax structure. However, if the institution wished to reclassify the asset they would be charged an additional tax surcharge. Such a penalty rate would curtail the reclassification of assets from 'holding' to 'trading' and prevent firms from benefiting under both sets of rules.

This solution would not solve all of the problems currently facing the financial industry, but it might help to support institutions in times of great crisis and would possibly even prevent panic selling of securities. Such actions can, potentially, act to stabilize markets and prevent crashes in the future.