How Mark-To-Market Accounting is Killing the Financial Markets
New Mark-to-Market Rules Are Precipitating the Financial Markets Meltdown
There are calls in Congress and from investment professionals to remove the mark-to-market rules as part of the bailout package on the House floor right now. Understanding what mark-to-market is and how the mark-to-market rules are intensifying the financial markets meltdown is the first step to changing it.
What Is Mark-To-Market?
Mark-to-market is a generally accepted accounting principle drafted by the Financial Accounting Standards Board to place a value on the financial instrument assets on a company's balance sheet. Financial instruments represent assets that derive their value from other assets. For example, mortgage-backed securities are "bundles" of mortgages sold as investments to banks and other financial institutions. The mortgage-backed securities derive their value from the mortgages that support them. If the mortgages have no value (i.e. no one is paying their mortgage), then the mortgage-backed securities do not have any value.
The goal of the mark-to-market rule was to objectively value assets that were difficult to place a value on. Clearer and easier-to-understand financial statements was the ultimate desired outcome.
As a Chartered Accountant, I welcomed the new mark-to-market rules and worked with many companies to implement them. Any rule that helps to value the balance sheet more accurately and more clearly helps the entire investment community. Unfortunately, the mark-to-market rule has had the opposite effect on corporate financial statements.
How Is Mark-To-Market Making The Financial Crisis Worse?
Banks are required to follow the mark-to-market rules, which state that the banks have to carry their financial instrument assets on the balance sheet at the value that they could sell them for on the open market at the date of valuation.
Many of these financial instruments are not going to be sold in the short term, so the short term value is less meaningful than the value of the financial instrument on the date of maturity.
How the mark-to-market rules have precipitated a crisis is that many of the banks' financial instruments, especially the mortgage-backed securities, do not currently have a market. Because of the subprime mortgage crisis, no one is willing to purchase these dangerous mortgage backed securities from banks. These are the assets that will most likely be purchased by the federal government as part of the bailout plan. When there is no market for a security, it must be written down, sometimes to zero, based on the mark-to-market rules. With assets marked down, banks' working capital is reduced and they find themselves in the liquidity crisis they are in right now. Wachovia, Washington Mutual, and Lehman Brothers found themselves in that position in the past two weeks and they all failed.
If the mark-to-market rules are removed and valuation of assets is done at maturity values, it will go a long way towards easing the current dangerous financial markets meltdown.
Sources:
http://www.mondaq.com/article.asp?articleid=66884
http://www.fasb.org/
Published by Angie Mohr CA CMA - Featured Contributor in Business & Finance
Angie Mohr is a Chartered Accountant and Certified Management Accountant who has worked with thousands of business clients from home-based entrepreneurs to rock bands to celebrity chefs. She is also the auth... View profile
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25 Comments
Post a CommentYou hear all these people on CNBC deprecating mark to market and nothing from the president's economists. We still have market to market and everyone knows it sucks everyone down with it. How can it even be applied to bundled mortgages? What genius allowed that?
good info ty
Great article, very informative :) Sheri
Very enlightening. I think I understand more now about the subject than I did before reading the article.
I have just been informed that this bill has passed and some of the people who voted yes accepted briefcases full of cash to vote yes from some guys on Wall street. OMG!!!!!!!
I'm certainly not suggesting that we do away with valuation- simply bring in a better valuation model that reflects true value more clearly. The Mark-to-Market has always been problematic as it causes large and artificial income and loss swings on the p&l that do not reflect what is actually going on. Financial institutions match their asset portfolios to buckets of liabilities (or projected claims, in the case of insurers). If the asset is producing income and will ultimately have value a year from now when it will retire the related liability, then what its liquidation value is today is meaningless. We need to have more but better disclosure, not less.
There are two things killing this country, Reaganomics and Narcissism. I say we don't do away with the financial laws that keep these meltdowns from happening. I would like to see them put back in place. What you have suggested here is more doing away with these laws. If one were to make armed robbery legal then yes there would be less crime, but there would be more victims.
Well yes, it would help the bottom line. But these rules are there for a reason. More relaxing of laws and rules would just delay the problem and make it even worse I think.
Thanks Angie, you did a great job explaining this
This is well written. You obviously know what you are talking about. I see some of this differently than you. One of your first comments by "you wish" Has almost nailed the real problems on the head. sure there are things that can be done to look around the real issues, and your suggestions would do a good job of that. unfortunately greed did cause this. Who could Blame the less fortunate for not wanting to bail out these people again? Who could blame these people for thinking Bush is a liar? You have named one thing that could help the situation. "You wish" has named the exact cause of the problem. The comments that attack and insult him show just how unknowledgeable America really is. Until We become more knowledgeable and less narcissistic as collective group, any bailout will be like placing a band-aid on the hoover dam during a leek. I too have much experience in the area of Bank Finance.