Nixing Mark-to-Market Accounting Is Not The Solution

I am a little confused. How will removing the mark-to-market accounting rule, an idea that is rapidly gaining traction, help solve the problem? If balance sheets are not prepared with market prices, it will allow companies to arbitrarily assign a price to the illiquid assets it holds. What kind of price are they going to select? Obviously, a high one!

To me, this will just lend less credibility to bank balance sheets because investors will assume the banks are choosing artificially high prices for the assets they get to assign values to. Will sovereign wealth funds, private equity funds, and hedge funds all of the sudden start to offer new capital injections into firms that are doing this? I highly doubt it.

One reason why WaMu, Wachovia, and Lehman Brothers went under was because nobody trusted their balance sheets enough to invest in them. Marking up those toxic assets arbitrarily would hardly result in more confidence than there is today.

Full Disclosure: No position in any of the companies mentioned at the time of writing

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7 Thoughts on “Nixing Mark-to-Market Accounting Is Not The Solution

  1. Even the Financial Accounting Standards Board’s couldn’t figure out how to deal with the mark-to-market accounting shortly after the Enron debacle. Even the Arthur Andersen accounting firm had problems with it which led to its failure too. Enron filed for bankruptcy 2001. The Financial Accounting Standards Board’s has had 7 years and they did nothing.

  2. Anonymous on September 30, 2008 at 2:00 PM said:

    I’m by no means an expert on these issues, but I can see the argument on both sides.

    To play devil’s advocate, there was the story of a woman who got a divorce and one of the strange stipulations was that the car would be sold and the proceeds given to the ex-husband.

    Just to piss him off, she sold it for $1.

    Is that the market price?

    It seems like it just is a fact that certain types of illiquid assets are hard to value. And substituting the current market valuation is not necessarily any more accurate than mark-to-model.

  3. Anonymous on September 30, 2008 at 8:28 PM said:

    Japan went into a recession in the late 80’s, I believe it started in 89. They are still in 1 today. I am no expert on the japanese banking system but have read books on it and the overwhelming conclusion is it was dragged on by the bad loans on the banks books. The Japanese government allowed these firms to to delay writing down their bad loans as most of the banks were insolvent. As a result, there was no motivation to clean up the loans and it took over a decade to work them through.

    Now we have the SEC being pressured into doing the same thing. What a shame.

  4. Freedom 45 on October 1, 2008 at 8:13 AM said:

    The best characterization I have heard was on CNBC yesterday when one guest said “just because I sold my house for 200K below market, does that mean my neighbor has lost 200K”? I am all for more transparency on what assets a firm holds but temporary market dislocations should not, by default, require a capital raise.

  5. Anonymous on October 1, 2008 at 9:34 AM said:

    I realize the below quote is a bit out of context, but still pretty funny…

    “”Onerous mark-to-market rules for certain financial assets that have no market value have worsened the credit crisis,” House Minority Leader John Boehner, R-Ohio, said in a statement released by his office.”

  6. Chad Brand on October 1, 2008 at 12:38 PM said:

    There are defenses built into car sales (used car prices) and even home sales (appraisals) so that if you wanted to estimate the value, you could to a certain degree of accuracy. But with ABS, you can’t get a decent estimate.

    As for someone who sells their house for 200K below market, yes, that would impact their neighbor. Homes are priced using comps. If someone paid X for your house, and your neighbor’s is identical, they would likely get a initial bid of X and no more.

  7. infoage on October 1, 2008 at 1:59 PM said:

    “As for someone who sells their house for 200K below market”

    I hate to state the obvious, but if someone sells a house for $, isn’t that “the market?”

    Further, if you are the neighbor’s bank, and said neighbor is asking to refi, what are you going to use as an appraisal? Past market, present market, future market?

    As the housing bubble inflated, everyone was appraising by projecting prices into the future. Why should that not hold true now–and in reverse???

    Say *you* are the bank, OK? It is *your* money the stretched homeowner is asking to borrow.

    Wouldn’t *you* be conservative in values? Otherwise, you are effectively calling a price bottom with each refi.

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