Subject: File No. 4-573
From: Mariah C Webinger
Affiliation: University of Nebraska-Lincoln

November 13, 2008

Ms Florence E. Harmon, Secretary
Securities and Exchange Commission
100 F Street, NE, Washington, DC 20549–1090

RE: SEC Study of Mark to Market Accounting, SEC Rel. Nos. 33-8975 3458747 File No. 4-573

Dear Ms Harmon:

Thank you for the opportunity to provide input into the SECs mark-to-market study.

Mark-to-market accounting serves two uses in the financial industry: (1) providing useful information to investors and (2) the basis for contracts related to bank reserves and loan agreements. The conflicts between these two uses provide the basis for the disagreements between users of mark-to-market information and the financial institutions that supply it. According to the FASBs proposed conceptual framework, the two qualitative characteristics that make information useful are its relevance and its representational faithfulness. Few can dispute the relevance of fair value information to users. But does the information as proposed in FAS 157 fairly represent the fair value? This is the point where users and the financial institutions who prepare the information part agreement. Many companies that are required to value assets and liabilities according to the FAS 157 rules believe the resulting valuations have a downward bias during unsettled economic times.

Banks, insurance companies, and other financial institutions borrow money from depositors, policy holders, and investors in the short term and invest these dollars in assets with much longer lives. Making these maturity mismatches is, in part, how these companies pay depositors, policy holders, and investors and make a fair profit. In times of financial fear, however, these folks may want to take their money out, which stresses financial institution liquidity because the long-term assets are not immediately redeemable in cash.

Accounting rules found in FAS 157 have evolved toward requiring financial institutions to value their assets based on what someone will pay for those assets today—right now—regardless of whether there is a willing buyer. When the financial markets are performing rationally, this concept can work. When runs for liquidity are allowed to happen unchecked, a vicious cycle is created in the accounting world that can have ravaging effects on a financial institutions balance sheet. As investors pull their cash out of an institution (or in the case of non-depository institutions like Bear Sterns, when margin calls persist and pile up unchecked), the institution is forced to sell assets at fire-sale prices. This quickly depletes the capital cushion the institution has, which, in turn, may cause failure. But it does not stop there.

Every other financial institution that holds similar assets may be required to mark down their assets to the same fire-sale price Because mark-to-market accounting standards are used for both financial reporting and regulation, this in turn causes capital erosion at all firms, which causes more forced selling of assets, which spirals into further write-downs. To demonstrate the terrible consequences of the downward spiral, a mini-version of this potential tidal wave of deflationary pressure occurred in Japan almost 15 years ago, and they have not yet fully recovered.

In the current environment only some favored financial institutions have access to Federal assistance. Other financial institutions lacking this access but who must borrow from those that do may have an added disadvantage. The favored financial institutions may influence the fair value inputs faced by the disadvantage financial institutions in a manner that further downward biases the already fire-sale prices. These favored institutions are then in the position to scoop up the disadvantaged ones at bargain amounts

Amplifying the run for cash phenomenon is the proposed change to FAS 140 and Fin 46(R) which will require banks to keep ALL securitized loans on their balance sheet. While this will increase transparency it will also require that banks maintain a 10% capital reserve for all the loans that previously were not considered part of their asset holdings (roughly half of all financial assets are currently off-balance sheet). Now banks along with investors are shrinking loan assets in a futile effort to raise cash.

In summary, during times of rational market behavior fair value measurement is superior to any other. The information is both relevant to investors and fairly represents the underlying economics of the thing being measured. In times of unusual economic stress where market participants may have control over some of the fair value inputs, it may not work well. How do we fix the mark-to-market accounting standard? First we need to detach the regulatory measurement of assets from the reporting measurement. For example the issue of increasing financial accounting reporting transparency by bringing all assets onto the balance sheet at fair value needs to be separated from the issue of the need to moderate financial institutions capital requirement burden related to these additional assets. Second, we should consider suspending fair value requirements for hard-to-value assets. Issues related to market participant influence over valuation inputs need to be settled before fair value measurements can effectively increase financial transparency without unintended economic consequences.

David Smith,
University of Nebraska - Lincoln

Mariah Webinger
University of Nebraska - Lincoln