Mark to Market Myths

If I read one more mark-to-market screed, I'm going to spit. The gist: An accounting change called FASB 157 pushed companies to mark their balance sheet items to market, and that's generally a good thing. It means that we have some sense of what toxic paper, real estate, collectibles, etc., on companies' balance sheets are worth, as opposed to what companies say they are worth.

Trouble is, that only works when there is a market. And in the case of much of the wacky paper causing all the current problems among financial services companies, there was a market, and now there isn't. It is not, as some are alleging, that people bought stuff that never traded, and are now crying at the idea of pricing it. Instead, it is that these things used to trade, and now they don't, even if they will likely trade again in future. Forcing people to price to a market than once existed, now doesn't, and likely will again, is dumb and pig-headed.

Further, we have a negative feedback loop making things worse. Marking newly illiquid assets to a non-existent market makes companies less viable, which causes default swaps to go swooping higher, and that in turn can lead to downgrades by rating agencies. Following the bouncing ball, that can lead to companies failing, which causes less liquidity and lower prices, and so on and so on. You get the picture. It's dumb and artificial.

Let's not get rid of mark-to-market -- that would be stupid. But we can fix it to handle the real world better. How about, off the top of my head, making marked pricing smoothed over 2-3 quarters in temporarily locked markets? I'm open to other ideas, but I'm highly wary about over-orthodox applications of rules in an attempt to live up to some sort of inappropriate standard.

Comments

[I'mfromJersey:]

It's hysterical to hear congressmen who know NOTHING about accounting or economics promise on TV that eliminating mark to market is the only right way to rescue the economy....

2008 Oct 01 01:23 PM

[AuGod!:]

By mark-to-market I would argue that the underlying mortgage loans themselves which underly the "securities" be unwound from their securities' prison and that each mortgage be reassessed based on that or even 35% less than present market value of the homes and at reasonable rates of interest with encouragement for the borrower to remain engaged. The actual "securities" which suffer due to underlying defaults would then be expunged from the system unless they could be rewritten as "cream of the crap" then sold on into the market if and when there is one. Many though sadly not all of Main street America would then benefit. but homes with families would be saved from being kicked out to the curb and would live to contribute to the recovery instead of being mired in litigation and debt. To me that is a solution which is comprehensive and not selective. Major haircuts all around? You bet, but an investment in America means just that not just the banks who created this mess, greedy shareholders (mostly hedgefund vulture types) and institutional investors who are now holding the bag.

2008 Oct 01 01:55 PM

[dwoods55:]

Taken directly from the FASB summary on Statement 157:

"In those situations, the reporting entity need not undertake all possible efforts to obtain information about market participant assumptions. However, the reporting entity must not ignore information about market participant assumptions that is reasonably available without undue cost and effort."

In other words, if there is no market, YOU DO NOT NEED TO WRITE IT DOWN!

Understand the basics before you rail against them Paul.

2008 Oct 01 02:06 PM

[The Realist:]

This makes no sense to me. None of these assets are marked to market right now anyway. They are all in the Level 3 asset class and valued at what the banks want them to be.

What a joke of an argument. If the banks actually marked all these things to market the banks would all have declared bankruptcy already.

How hard is it to understand that every single bank is currently insolvent? There is absolutely no transparency right now because it would destroy the market. Isn't it obvious enough that this is the case when the government does everything in its ability to help these banks lie, cheat and steal so that we don't know what is really there.

You think this would make the slightest difference anyway. Banks are not lending to each other because they don't trust the assets on the other banks' books. What makes you think that making up values for garbage securities is going to give them more confidence. Just the opposite. Each bank will know how much BS their books are and they will distrust the other banks' books even more.

2008 Oct 01 02:17 PM

[blackhorn:]

thank god that other readers are policing this nonsense...

2008 Oct 01 03:03 PM

[taxd2deth:]

Mr. Kedrosky's desire to simply declare the system broken, without specific, exacting examination of even one bank's application of the new rule and why it matters or doesn't, and then simply throwing out a completely made up and nonsensical blending standard, again with no concrete examples or even attempt, put him in the same class as Bernanke and Paulson. Blog writing invites poor academic skills and pure BS, and even the smartest guys on the block soon just fill the page. Also, the reality of what has actually happened has little to nothing to do with that rule in any event, it is a scapegoat for multi-level Enron type accounting frauds which seems to vary, bank to bank as I examine their situations. Many (if not most) banks seem to have none of these odd valuation issues, incidentally, if you examine enough of the statements available for free on line. The issue for most of those banks is that they had investments in Fannie/Freddie and relied on the government oversight to protect them. So much for oversight.

2008 Oct 01 05:34 PM

[Steven Hansen:]

i have repeatedly requested examples where mark-to-market rules have endangered or brought down a company. i have been looking and have not found one case. i would reconsider my position if a case was shown.

throughout my career, i have been an enemy of the bean counters. they have caused a shift from product driven companies to profit driven companies (i suggest both are equally important). they have cooked the books to the point you cannot really understand the health of the company.

the accounting of assets to mark-to-market is the beginning of return to reality. it forces a realistic appraisal of assets. it reduces funny-money profits. it forces a universal standard to compare companies. it is good for the long term investor.

2008 Oct 02 12:10 AM

[Shiv Kapoor:]

Agree with Paul - Mark to market rules make no sense when the market values are established within a market in dis order.

During early December 2007, I had written an analysis titled And I, Am a Monkey's Uncle (https://news.glgroup.... Then I had opined that further declines were in store for the financial services sector; what more I had stated that decline would be rather more severe compared with the past on account of mark to market losses.

I do not see anything wrong with the standard. Instead, I see problems with guidance on its implementation.

Fair value accounting pre-supposes a willing buyer and seller transacting in an orderly market. In such a situation the market value of an asset is indicative of its economic value; thus mark to market rules make good sense.

When the market is not orderly, I believe the mark to market rule should no apply; a distress sale in a disorderly market cannot be indicative of the true economic value of an asset. Why then should the mark to market rule apply in such circumstances?

In my view, when application of a standard results in the reflection of a warped picture of economic reality, a true and fair view is not provided to the users of financial statements. In such circumstances, the users of financial information would be better served by:

1. Exercise of professional judgment in estimating the fair market value which should have prevailed had the market been orderly.

2. Disclosure of historic cost.

3. Disclosure of mark to market valuations in a dis-orderly market.


The users of financial statements need to get used to looking beyond the recognition in order to take from the financials what they need. We live in a far more complicated world today, and just as I learned to use computers, users of financial statements must learn to read them.

2008 Oct 02 09:43 AM

[TBill:]

Very good, Shiv. It is mark to market that has turned isolated failures into the domino effect. Mark to market assumes rational pricing on the merits of the paper. We all know that markets get irrational now and then.

2008 Oct 02 11:12 AM