Ten seemingly short years ago, the low-water point for the U.S. stock market occurred on March 9 at 666.79. There are numbers of theories about why the decline stopped on a dime and reversed. The best and most logical one is also the simplest explanation. Alas, the following was never going to be made into a Hollywood movie.
First, a little background. The Financial Accounting Standards Board released Standard 157 (FAS) in September 2006. But the effective date for implementing it was November 15, 2007. The S&P 500 topped out a month earlier on Oct. 11 at 1,576. For the next sixteen months, we all lost trillions of dollars in values of financial assets. This included bonds, stocks and all the mutual funds and exchange traded funds containing them.
When did the bleeding stop? On March 10, it became apparent that Congress would force a change of this accounting rule. On that one day, the S&P 500 jumped 6.37 percent. By year-end, it was another 39 percent higher at 1,115.
How could one change make that much difference? Let’s examine the mark-to-market accounting standard very simply. Suppose that you own a home. Further suppose you must report the value of your home to the world once every quarter and that this value is very important for you to be able to continue doing business as a private citizen. Right now, you would probably feel all right about that. Let’s say it is back up to $200,000.
Now suppose that for some reason, the interest rate for new home loans jumped to 10 percent. You are minding your own business, but you want to sell your home and move to Florida. Due to this interest rate shock, you learn that no one – absolutely no one – is willing to even look at your home. Everyone is waiting until this new infernal interest rate drops back to a more reasonable number.
The powers that be now tell you that you cannot continue in business because your home is worthless. No interest, no bids equals no value, zero, nada. That does not make much sense to you, does it? Neither did it as it was applied to all of the various assets owned by Lehman Brothers, Bear Stearns and other big financial institutions.
But the rules said, no bids today equals zero value. How many of us could be solvent under those circumstances? If you had any debt, you would be sunk and bankrupt. Thank God for some level-headed contrarian people who kept yelling louder until they were heard, people like Brian Wesbury, my favorite economist, and Steve Forbes.
There are still some rumblings even such a short time later that we should be using a similar rule involving so-called fair value. My cynical side says that this would undoubtedly be a huge boon to accountants’ billable hours. Just as war is too terrible and important to leave to the generals, my opinion is that standards like these are too critical to be left to the FASB.
(Advice is general in nature and not intended for specific situations. Past performance is no guarantee of future results. All statistics from Worden Brothers, Inc., TC2000, 2019.)
Ron Finke is president of Stewardship Capital in Independence. He is a registered investment adviser. Reach him at firstname.lastname@example.org.