Sen. John McCain (WDCpix)

PHOENIX—Lost amid the Senate’s Wednesday night passage of a $700-billion Wall Street bailout plan was an effort by Sen. John McCain and others to “fix” an accounting rule that they believe has helped create the crisis.

The Securities and Exchange Commission and the Financial Accounting Standards Board, or FASB, on Tuesday issued “clarifications” regarding the rule, known as mark-to-market. The new directive allows companies to value their assets according to their estimated future cash flow, rather than current market prices.

Illustration by: Matt Mahurin

There are few buyers for many of the assets on the books of financial institutions, especially mortgage-backed securities. That makes them difficult to value. The price uncertainty has driven their market value down as much as 80 percent, threatening the solvency of many banks.

Banks and securities firms have already written down $500 billion worth of mortgage-backed paper as home prices have fallen and foreclosures skyrocketed.

The Senate bill calls for the SEC to issue a report to Congress on the effect of mark-to-market accounting on the financial industry within 90 days of the legislation becoming law. It also gives the SEC authority to suspend the mark-to-market rule.

The bill now moves to the House, where a vote is expected Friday. Members of the House Republican Study Committee are saying they want the mark-to-market rule scrapped.

McCain first called for repeal of the accounting rule in March. His presidential campaign issued a statement Tuesday supporting the SEC decision to relax the rule.

“John McCain is pleased to see that the SEC had finally decided to permit alternative accounting methods to mark-to-market accounting for securities where no active market exists,” McCain’s senior policy advisor Doug Holtz-Eakin said.

The American Bankers Assn. also praised the SEC’s action, saying “This guidance will help auditors more accurately price assets that are difficult to value under current market conditions.”

Critics, however, contend that allowing companies to base the value of their assets on unknown future cash flows will only cloud their true financial condition.

William Black, former deputy director of the Federal Home Loan Bank Board, said Tuesday that the SEC’s decision to relax the rule is an attempt to “cover up” the extent of the financial problems facing lenders. Black blames a similar accounting change for worsening the savings and loan blowup in the 1980s.

The SEC, McCain and others “want to use the same phony accounting to try and cover up losses, which will only make the losses much greater in the future,” said Black, now an assistant professor of law and economics at the University of Missouri at Kansas City.

But many economists, business leaders and politicians are urging modification or suspension of mark-to-market accounting for lenders holding huge amounts of mortgage-related securities that have no market.

“Assets should not be marked to unrealistic fire-sale prices,” wrote William Isaac, former Federal Deposit Insurance Corp. chairman, in a Sept. 19 Wall Street Journal op-ed article.

Bob McTeer, former president of the Federal Reserve Bank of Dallas and now at the National Center for Policy Analysis in Texas, said on NYTimes.com on Wednesday that suspending the mark-to-market rule “would make a big difference” in easing the financial turmoil. “Mark-to-market was never intended for use in a declining market,” he said.

And in a commentary appearing Monday on Forbes.com, former House Speaker Newt Gingrich urged Congress to suspend the mark-to-market standard to “relieve stress on banks and corporations.”

Accounting groups, consumer advocates and bank analysts, however, oppose scuttling the mark-to-market rule.

The Center for Audit Quality, a nonprofit group funded by accounting firms, sent a letter Tuesday to Congress urging lawmakers not to abandon the rule, arguing that proposals to revoke it “are not in the best interest of investors or the capital markets.”

“The principles of mark-to-market accounting are rooted in the fundamental virtue of transparency and are central to informed market decisions and efficient allocation of capital,” Cynthia M. Fornelli, the group’s executive director, stated in the letter.

Representatives of the nation’s big four accounting firms also object to the rule change. “It’s just bad for investors,” Beth Brooke, global vice chair at Ernst & Young LLP, in Washington, told The Wall Street Journal Wednesday. “Suspending mark-to-market accounting, in essence, suspends reality.”

And Barbara Roper, director of investor protection for the Consumer Federation of America, told The Journal that, “Allowing companies to lie to investors and lie to themselves is not the solution to the problem–it is the problem.”

Black, the former bank regulator, said there is substantial evidence that many lenders have already abandoned mark-to-market accounting by overstating the value of their mortgage-related assets. He said the recent takeovers of Washington Mutual by JP Morgan Chase and Wachovia by Citigroup revealed that losses at the two acquired banks were far greater than anticipated.

“These were enormous losses in the subprime mortgage market that they pretended didn’t exist,” Black said. “That’s called fraud.”

Rather than suspend mark-to-market accounting, Black said federal regulators should conduct more thorough bank examinations of all lenders heavily invested in the mortgage-backed securities. “Look for the ones that have heavy subprime exposure and take supervisory control of the institutions,” Black urged.

Illustration by: Matt Mahurin

Related Video: Pain on Main Street

As lawmakers continue fighting on Capitol Hill over a $700 billion taxpayer bailout for banks and lenders on Wall Street, the foreclosure machine grinds on and the mortgage crisis at the heart of the problem continues to worsen.

Every day, people show up looking for help at the modest offices of United Communities Against Poverty, a housing counseling agency in Prince George’s County, Md., in suburban Washington. Homes are going into foreclosure at one of the fastest rates in the nation here, and to chief counselor Caprice Coppedge, it’s hardly surprising that the bailout bill doesn’t have much in it to help them.

Illustration by: Matt Mahurin

“I’m not shocked,” she said. “Each one of these so-called rescues hasn’t done much to help homeowners. There has to be a little bit more of a solid plan. I don’t understand why they

Image by: Matt Mahurin

When it comes to the bailout, homeowners understand one thing for sure: They aren’t too big to fail. A long-sought measure that might help some of them — changing federal law to allow bankruptcy judges to modify mortgages — faces tough odds, with the lending industry strongly opposed to it.

Even if gets approved, some borrowers can’t afford bankruptcy attorneys or don’t want to file. Still, housing groups estimate the change would keep some 600,000 families in their homes, which is why they have been pushing the idea.

To help even more, Senate Democrats want the government to modify as many of the loans it buys as possible. But just because the government owns all those bad mortgages doesn’t mean it can do a massive restructuring to make them more affordable.

In taking on toxic loans, the government faces a huge Humpty-Dumpty problem — mortgage-backed securities were sliced into pieces and sold that way to investors around the globe. Spending all that taxpayer money to buy those securities still won’t ensure the government can own or control them all, so it can’t redo loans on a large scale. Even $700 billion won’t be enough to put all the pieces back together again, said Adam Levitin, a Georgetown University law professor and expert on the credit industry.

The small percentage of loan modifications that might get done will be “random and arbitrary,” and not based on the merit’s of a homeowner’s case, he said. Not to mention that second mortgage holders regularly refuse to do loan modifications, and many subprime homeowners took out two mortgages.

Given all this, the bailout ends up rewarding the most egregious of the subprime lenders — the ones who made the most abusive and predatory loans and who disproportionately targeted minority borrowers — since they’ll be the ones with the most toxic securities to buy. Banks that didn’t do as much subprime lending won’t need to sell off as many loans, and they won’t get as much government money, Levitin said.

And don’t count on banks being subject to tighter regulation in return for their bailout, he added. It’s possible that banks and lenders in a few years might use the same taxpayer dollars that rescued them to stave off regulatory reform of the financial markets, the ultimate irony of the bailout effort.

That very real possibility could be avoided by having Congress fast-track approval of a bailout but insist on regulatory reform within a short time frame, and specify that it can’t be filibustered, said economist Dean Baker, co-director of the Center for Economic and Policy Research. Otherwise, as the bill now stands, banks seem to be escaping the consequences of their past lending behavior.

“It’s pretty insidious,” Levitin said. “We’re bailing out banks that got us into this mess because of years of abusive and predatory loans. And there’s no price to pay. I find that deeply troubling.”

No where is it more troubling than places like Prince George’s County, the nation’s wealthiest black suburb, which has been hard hit by subprime loans and foreclosures. Credit scores here rank at or above the national average, but the community has more than its share of subprime loans, with almost twice as many homeowners holding high-cost mortgages as the national average.

That pattern holds true elsewhere. In majority black and Latino communities nationwide, nearly half of all mortgages made in 2006 were subprime loans. All during the housing boom, racial differences became more pronounced as income increased — so middle-to-high income black and Latino borrowers were more likely than non-minority borrowers with modest incomes to have subprime mortgages.

Iris Pulliam, 51, a social worker in the District of Columbia public schools, refinanced her Prince George’s County home with a 9.5 percent Countywide loan three years ago. She tried to do some research before refinancing and refused the adjustable rate mortgage the lender first offered.

Looking back, Pulliam said she wasn’t aware she could have had a real estate attorney with her at the closing, and didn’t comprehend all the additional fees included in the loan before she signed. Still, she kept up the payments until her husband died almost two years ago, leaving her with just one income to pay the mortgage and take care of her 15-year-old son.

Pulliam began falling behind on her mortgage, and tried working out a loan modification with Countrywide. But the lender agreed only to a repayment plan that would increase her monthly payments.

She stood in a long line in the July heat to try to get a loan restructuring through the Neighborhood Assistance Corp. of America, a housing advocacy group. But Countrywide still hasn’t approved it. A Countrywide representative called her recently to discuss her case, but she called back again and again and couldn’t get through to anyone.

At this point, Pulliam has taken on a part-time job in addition to her full-time position and has dipped into most of her retirement savings to keep up with the mortgage. Her day starts at 5 a.m., and she gets home around 8 p.m. She’s thinking of trying to refinance again, if possible. One thing she’s well aware of: The bailout plan isn’t going to do a thing for her.

“It’s not taking the average homeowner into consideration, to me,” she said. “I feel that they’re putting all this money out for all these big money industries, investment companies and firms, and they should do something more for the average homeowner, to try to make sure we keep our homes.

“I think the scales are tipped toward the mortgager who has billions of dollars. For the little person, we might as well be off the scales.”

Modifying bankruptcy laws won’t help her, Pulliam said. She wouldn’t be able to afford a bankruptcy attorney. Congress could make a difference by forcing subprime lenders in future to be “upfront and above board,” she said. She’s not convinced that will happen.

To Coppedge, the housing counselor, part of the problem is that people need the sort of help neither Congress nor the Treasury Dept. is talking about. Coppedge, a former mortgage banker, is well aware that keeping credit flowing will help people in the long run to buy homes or take out loans — in that sense, she sees the need for a bailout.

But the people who come to her could use help too, like emergency assistance to cover even a month or two of mortgage payments to stay in their homes. For along with subprime loans, Coppedge noted, higher gas and food prices are cutting into the ability of the elderly and other homeowners on fixed incomes to pay their mortgages.

“I see a lot of clients who are not your typical five or six months behind on their mortgage,” Coppedge said. “I see some individuals, especially the elderly and the handicapped, who were preyed upon and asked to refinance their mortgages to make repairs or whatever the case may be. And these people just need one or two months of mortgage assistance to catch up, and catch their breath, and be able to get back on track.”

As part of the bailout, Democrats in the House and Senate want government agencies like the Federal Housing Admin. to expand their lending programs and help more homeowners, building on an effort included in the mortgage rescue bill. Under that program, the FHA will provide $300 billion in guarantees for lower-rate mortgages refinanced by lenders willing to accept a loss on the loans.

The program, which begins Oct. 1, is voluntary, and no one seems sure how well it will work. Coppedge noted that most of her clients either don’t have enough income or owe so much more on their mortgages than their homes are worth that they usually don’t qualify for FHA or other government programs.

On Capitol Hill, some lawmakers and economists are questioning whether the bailout plan will do enough to ease the credit crunch and to hold off a recession. But to groups like the Center for Responsible Lending, they are asking the wrong questions. Unless any bailout also deals with the problems of people facing foreclosures, it can’t fix the economy.

“The bailout will not solve our economic problems because it will do virtually nothing to stop the foreclosure epidemic,” the center said in a statement. “Continuing foreclosures will drag down the economy even further.”

John Taylor, president of the National Community Reinvestment Coalition, which represents housing advocacy groups, called it “unconscionable” for Congress to approve a plan that never addresses the underlying problem behind the crisis. His group met with Federal Reserve Chairman Ben Bernanke on Monday to complain that the government should first help homeowners facing foreclosure, before shoring up Wall Street.

Pulliam says the bailout for Wall Street mostly means that she’s on her own to save her home. Does anyone in power understand what she’s going through?

“The CEO of Countrywide wouldn’t know,” Pulliam said. “Or the vice president of Countrywide; or the Bank of America. They’re all out buying up other banks while the consumers have trouble keeping their houses.”
Pulliam grew up in a house with a white picket fence, and she wants that same sense of the benefits of homeownership for her son. She’s thinking about taking in a roommate to help pay the mortgage. Her sister is also facing foreclosure, and they’re considering sharing a household to solve both of their difficulties.
“I’ll do everything possible that’s legal and above board to keep my home,” Pulliam said. “That’s what I want for my son — a stable neighborhood environment.”

Like other troubled borrowers dealing with a crisis that seems far removed from the political posturing on Capitol Hill, Pulliam seems willing to pay whatever price it takes to keep it.