The Enron Economy

From this article at HuffPo

Federal Reserve Chairman Ben Bernanke's 10 March suggestion the federal government abet manipulation of mark-to-market accounting practices reeks of pandering to Wall Street with little regard for U.S. or foreign investors. Bernanke's proposal would allow banks to ignore existing guidelines requiring firms to value assets at what they would be worth if sold on the market today. Instead of having to admit their toxic assets are currently worth 5 to 10 % of original value, under Bernanke's proposal they would claim these failed investments could be profitable holdings...sometime in the future.

Imagine walking into a bank with the intention of taking out a second loan on your house. Instead of having to admit your home has actually lost 20-30% of its value over the last 18 months, you instead insist the bank approve your loan because it could be worth double what you originally paid once the current economic crisis has passed. That is exactly what Bernanke is proposing banks be allowed to do.

This is not a trivial matter, as those who invested in Enron painfully discovered. Enron employed accounting practices that allowed the firm to claim anticipated future profits as real today. The result: Enron executives recorded profits on what actually turned out to be astronomical losses. Tighter guidelines concerning mark-to-market accounting were supposed to prevent a repeat of this fiasco, and to protect investors from future efforts to use exaggerated estimates as a means of artificially driving up stock prices.

Mr. Bernanke, a member of the Federal Reserve--where obfuscation, opacity and vague statements are standard practice--is wise enough to avoid terms that immediately bring Enron to mind. Instead, he prefers to refer to his latest proposal as a move to price assets at "their underlying economic value...which would probably be higher" than the current market rate. This Fed-speak may impress legislators; it should cause nothing but discomfort among investors.

This type of fanciful bookkeeping and dependence on computer modeling is exactly how we landed up with a raft of ailing financial institutions in the first place. By convincing investors the models showed assets rising in value, the bankers and some insurance firms (i.e., AIG) were able to drive up their stock prices. We are all now living with the consequences.
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Consider, for a moment, the likelihood that such estimative modeling will be used to value the troubled assets some banks are now looking to shed. Rather than pay market prices for these troubled assets, you and I are inevitably going to be asked to purchase these accounting problems at an estimated value far exceeding what they are presently worth. Great for the banks, not so wonderful for the taxpayers.