05/04/2009 05:12 am ET Updated May 25, 2011

It's Like Trusting A Drug Addict To Arrange His Own Intervention

Markets this week expressed approval for the European Central Bank finally lowering interest rates a quarter point, down to 1.25 percent, with perhaps another quarter point to follow next month. But more importantly, there was celebration for the loosening of asset valuation rules by the Financial Accounting Standards Board, whereby it will be easier for bankers to avoid "mark-to-market" appraisals on their troubled assets. As bankers have argued, "mark-to-market" accounting -- valuing one's assets by their actual worth in the current market, as opposed to what they were once worth or could someday be worth given convenient assumptions -- should be forgone when markets "stop functioning properly."

Simplified, the rule changes this week will give bankers and holders of troubled assets more leeway to avoid finally biting the bullet and writing an asset off as a loss. As Patrick Finnegan told the Wall Street Journal, the new rule will now make companies' financial statements reflect the "management's assumptions", rather than something far less arbitrary or biased, such as the market. Or in other words, it is as if we are leaving it up to a drug addict to arrange his own intervention. As long as banks are allowed to continue denying the true toxicity of their toxic assets, the longer the current financial impasse will continue. But if these banks are all of a sudden forced to eat huge losses, their balance sheets will resemble Swiss cheese, and Timothy Geithner will be forced into the highly unfashionable position of groveling before an ever-more populist Congress for more funds.

Welcome to the Catch-22 of the financial crisis. Geithner's recently unveiled plan for toxic assets, the PPIP approach, calls for private investors to buy up toxic assets with government backing. Originally, the fear was that banks would not be willing to sell of these assets at market prices because that would mean finally accepting the loss. But now, with more lax rules for asset valuation, leaving it in the hands of the bankers, the Geithner plan's problems are reversed. It is now the investors who will have to be cajoled into action to buy assets that they will presumably consider overpriced.

And so, in the tradition of the financial industry during years past, short-term gains are trumping long-term sustainability. Investors relished the retreat from "mark-to-market" this week, and the market enjoyed moderate gains. But it could very well drop again. And the more long-term demand for finally biting the bullet and ridding the banks of their toxic waste could be shunted aside yet again. Geithner's plan surely wasn't perfect to begin with, but it had its merits. The government's power to manage the PPIP asset sell-off has been handed back to the bankers, whose argument foments fear of more bailout funds and further financial collapse. As it stands now, this argument is prevailing. The junky in the room is calling the shots with the claim that rehab will hurt more than continued dysfunction. And the prospects for finally breaking the impasse are kicked ever further down the road.