Potential New FASB Mark-to-Market Rules

FASB is looking at a further expansion of mark-to-market rules. One of the concepts being discussed is marking all loans to market. This seems like a very difficult task in the absence of much of a securitization market, which we're all rather sour on anyway due to the moral hazard. When a bank makes a loan to the corner drugstore (if it still exists in the future) who else would want that loan the next day? So what would the loan be worth? If banks have capital accounts of about 10% of their assets (wishful thinking these days?), if the marked-to-market loan suffered a 10% drop in value the day after it was made, the imaginary capital assigned to that loan would be wiped out. Anyone care to own a community bank under these conditions?

In the past, if examiners "classified" a loan, there was a capital haircut. This facilitated small business lending. Imagine a bank has a niche in lending to these mythical corner drugstores, a long experience of loan-to-value, credit risk, etc. It's a profitable business, and someone leaves the bank and starts to compete. Being new, corners are cut, rates are lowered and higher risks are taken. Yet the old bank loses some share but doesn't relax it's standards. When the new bank becomes illiquid and has to sell the loans, now the old bank may need to write theirs down to the distress price, even though their portfolio is higher quality. In the past, this sort of marking process was reserved for assets that traded, not all assets.

Now that the government owns stakes in big banks, it's time to look for the moral hazard--a regulatory climate that subtly favors the government-owned enterprises. Big banks might actually be able to securitize loans and have a more favorable mark than an unsecuritized loan from a small bank. The financial products czar, who's supposed to approve products, is another potential change in the environment. Upstarts typically compete on service or product innovation. If a product czar inhibits product innovation, doesn't that bode well for branded service providers over the upstarts?