Mark Sunshine

Mark-to-Market: The Bogeyman of the 1930s Is Back

I appreciate the comments that everyone is making to this article. I really didn’t intend to start a firestorm as much as write a nice short piece supporting the great work of Wesbury and Stein.

However, now that the debate has started I guess I shoudl weigh in…I disagree with everyone who thinks that mark to market accounting is a small problem or of limited application. And, yes, for those of you who think I have lost my memory or sanity I have not. I do remember lower of cost or market accounting, vividly in fact. However, it is the intersection of the expansion of mark to market accounting and the capital markets (or lack thereof in the current market) that is killing the banking sector.

And, I noticed that not a single comment related to 141R which went effective on 1/1/09 and effectively expanded mark to market accounting to all financial assets of all banks. Now, I know that 141R only applies in a merger situation but the effect of that rule is to make all bank management teams run their institutions as if they are constantly applying 141R to their portfolios. 141R is just starting to infiltrate through the banking system but give it a little time…it will infect all banking decisions in short order.

I also didn’t happen to notice anyone discussing the ability of companies to manufacture earnings by pretending that they aren’t going to repay their liabilities and marking them to market. Two of the bigger abusers of that part of the rule were Lehman and Bear (RIP for both of them). As I recall Merrill was pretty big in that game of pretend as well.

I hope the debate continues and that FASB, the Administration, the SEC and/or Congress fix this rule.
Obviously, bad assets are just plain old bad and shouldn’t be treated as anything other than bad. Accounting rules shouldn’t be used to make bad assets look good or delay the recognition of credit losses.

But by the same token the efficient market’s thesis (which underpins mark to market accounting) has severe limitations and if misapplied (as I believe the current version of mark to market accounting is doing) creates terrible distortions. The market isn’t all knowing and always correct and that is because the market often doesn’t have real information about the real borrowers behind the loans that are being priced, the market doesn’t have the time to digest the information and the market just isn’t liquid enough to price all the different loans that exist (it isn’t liquid enough to effectively price all of the publically traded companies that exist).

Thanks for reading and thanks for commenting.