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September 24, 2017

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While the G-20 leaders temporized, the U.S. changed accounting rules

The G-20 summit meeting in London has come and gone and there is an agreement — of sorts. But don't expect the compromises adopted there to bring about an end to the worldwide recession anytime soon. Mainly they serve to paper over fundamental differences in priorities for getting the major economies going again.

President Obama sought specific commitments by governments to pump prime their economies with stimulus spending. France's President Sarkozy initially insisted on an international regulator to ensure that a U.S. origin economic disaster never happens again. Neither President got anything close to what they wanted.

Even so, some agreement is better than none at all, and the pledges to increase the capital of the International Monetary Fund by US$1.1 trillion will provide a lifeline to the most stressed of the world's poorer economies. Other than that, communique language that governments should spend whatever it takes to revive their economies merely cloaks French and German refusal to consider new stimulus programs now.

Similarly, the call for more financial regulation worldwide states an obvious need, but the G-20 consensus has already been breached by a change in accounting rules in the United States. Submerged in all the hoopla surrounding the London summit, the change in mark-to-market rules by the Federal Accounting Standards Board could well have a greater effect on the U.S. and world economies than what was accomplished in London.

This change makes it much easier for American banks to defer writing down the value of their illiquid assets, and amounts to considerably less regulation rather than more. It will give U.S. banks a lifeline by allowing them to revalue their toxic assets upward as they strive to meet minimum reserve requirements, but it also risks delaying more effective measures to deal with the crisis.

Supporters of the change contend that the old rule paralyzed banks by forcing them to value their toxic assets at less than their "real worth" in a "normal" market. This depletes the banks' capital on the books, restricts their ability to lend, and requires raising more capital to avoid insolvency.

Wall Street lauds the change, maintaining that mark-to-market accounting made little sense for American banks. Critics say the new rule is "mark-to-make-believe." Rather than setting a consistent standard for valuing assets, each bank now can calculate asset values based on its own models. Investors and regulators will have less reliable information, while banks can cloak the truth that they are insolvent.

The disparate viewpoints on mark-to-market rules get at the very heart of politicians and economists' disagreements about how to revive the banking system in the U.S. This is not a new argument. President Roosevelt suspended mark-to-market rules during the Great Depression in 1938, in an effort to keep more banks from failing. The reinstatement of these rules in 2007 was controversial, but could be described as an effort to keep banks honest as the sub-prime mortgage crisis began to rear its ugly head and the paper guarantees of credit default swaps exceeded the value of the entire U.S. stock market.

The rule change, forcefully advocated by the American Bankers Association and Wall Street, reflects a belief that it is more important to keep banks afloat than it is to keep them honest. This is also the underlying presumption — though never stated — of Treasury Secretary Geithner's plans to put the banks back in the business of lending by having public-private partnerships purchase their toxic assets with 85% non-recourse financing from the government.

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