Friday, February 6, 2009
by Marc Lichtenfeld, Senior Analyst & Healthcare Specialist, Smart Profits Report
and Martin Denholm, Managing Editor, Smart Profits Report

Dear Smart Profits Report Reader,

598,000 jobs lost in January - the worst in 34 years…

… and just to keep us on our toes, the erratic stock market reacts by zooming higher. This on top of an unsurprising Washington holdup in passing the economic stimulus package, too.

One can only imagine that the market is shrugging off the news because the abysmal figure from the Labor Department didn’t stink up the joint quite as badly as feared. It’s like being thankful when your son escapes injury after taking your car without permission and backing  it up through the closed garage door.

But make no mistake… the market will not be able to continue rallying on horrible unemployment numbers, no matter how much worse the expectations are.

There is something out there, however, that could launch stocks sharply higher in the short-term…

Debits And Credits

If thinking about accounting rules puts you to sleep, you’re not alone. But it’s imperative to pay attention to a change in mark-to-market accounting rules that could make stocks as explosive as Christian Bale on a bad day.

Mark-to-market accounting, also known as “fair value accounting,” occurs when companies have to value assets based on their market price. Sounds reasonable, right? However, many financial institutions carry very thinly traded complex derivatives on their books.

And during adversity like today, when these assets become distressed, a fire sale on prices can have adverse effects on a company’s balance sheet and impair its ability to lend, due to capital requirements.

This fair value model has its supporters and opponents…

Pros… Cons… And Fuzzy Math

Arguing against fair value accounting, prominent figures like Steve Forbes and Newt Gingrich say it should be eliminated in order to free up the balance sheets of these financial institutions.

But proponents contend that fair value accounting is the only way for the public to accurately gauge a company’s financial health. Previously, companies estimated the value of the assets themselves.

It’s a valid argument that during a severe downturn, fair value accounting can accelerate the deterioration. As more assets become distressed, companies’ balance sheets worsen along with them.

However, to have companies simply “make up” the value of these assets strikes me as foolish.