Dropping Mark-to-Market is a Bad Idea
When I first started hearing buzz about dropping “mark to market” accounting rules it sounded like a very bad idea to me. That said, it’s obviously not an issue I’m deeply versed in, and I heard some disagreement among folks who seem credible. But just as the Federal Accounting Standards Board was gearing up to relax mark-to-market rules, CAP’s Associate Director for Financial Markets Policy, David Min, was putting together this detailed explanation of what mark-to-market is and why we ought to keep it.
First he lays out why it’s the right standard, and then he argues (persuasively I think) that this FASB action is likely to compound our “animal spirits” problem and continue keeping investors in a maximally risk-averse posture:
So what would happen if FASB or regulators decided to repeal or suspend fair-value accounting rules? Well, any such moves could have severely deleterious effects. First, they would likely undermine investor confidence, decreasing transparency and increasing concerns about the accuracy of bank financial statements. This could have the effect of prolonging or worsening the credit crisis.
Second, the temporary or permanent cessation of fair-value accounting would set an unbelievably bad precedent—one that could wreak major damage to the integrity of U.S. securities markets. The setting of U.S. accounting standards has long been an independent nonpartisan process, free from political pressure. This is no small part of the success of the U.S. capital markets as it has created strong investor confidence that the rules of the game—the standards by which U.S. reporting companies disclose their financial results—are fair and will not change suddenly and arbitrarily.
Both of those sound right to me. On the second point, especially, it’s worth noting that it’s not as if what FASB did here was bow to longstanding critics of mark-to-market. The loudest voices calling for its dilution were the people who benefitted from marking to market when things were on the upswing, and then were hurt by it during the downturn. People behaving opportunistically is nothing new, but it’s bad for regulators to be willing to play calvinball like this and just switch accounting standards around to whatever happens to be more beneficial to certain firms.
It’s worth noting that part of the background to this crisis is a series of breakdowns by key supervisory institutions. This goes back to the dot-com bubble and bust. That stock market crash revealed substantial corruption in the practices of the major accounting firms in a way that was never really resolved. And the regulatory gaps were plugged by the Sarbanes-Oxley bill that’s almost universally seen as a failure—simultaneously burdensome to comply with and substantively toothless. Then more recently we’ve seen that the bond rating agencies can’t be trusted, and yet they’re still all there and still playing a crucial quasi-official role in the economy. Additional funny business with accounting and regulatory oversight is only going to further inspire people to fear that lurking behind any potential investment opportunity is some kind of scam that you’d do well to steer clear of.
30 Responses to “Dropping Mark-to-Market is a Bad Idea”
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April 3rd, 2009 at 3:25 pm
Hey all, When people use the term “animal spirits” is it safe to assume that what they mean is irrational behavior?
April 3rd, 2009 at 3:28 pm
по теме…
That said, it’s obviously not an issue I’m deeply versed in, and I heard some disagreement among folks who seem[...]…
April 3rd, 2009 at 3:28 pm
Whose picture is that? That is horrible.
April 3rd, 2009 at 3:48 pm
It’s the Financial Accounting Standards Board, not the Federal Accounting Standards Board. It’s not a government agency.
April 3rd, 2009 at 4:05 pm
The enthusiasm for “mark-to-market” accounting reminds me of the Simpson’s episode where Sideshow Bob explains his tattoo “Die Bart Die” by explaining “It’s German for `Die Bart Die’”. The jury lets him off on grounds that nobody who speaks German could possibly be bad. Similarly, people defend M2M on grounds that nothing that marks to market could possibly be bad.
The first reason to be suspicious of M2M is that it was an `innovation’ cooked up in the nineties/oughts, a period we now realize where accounting went to hell. It was used by Enron (after the fact people described Enron’s accounting as “mark-to-model”, but at the time everyone understood what Enron was doing as “mark-to-market”).
Jane_in_Colorado left a great comment on M2M which everyone should read:
http://www.motherjones.com/comment/reply/1810/13213
“. . .asset appreciation isn’t really worth a heck of a lot until you sell, is it? It’s not money in your pocket until you realize the difference between purchase and sale prices as income. The same logic used to apply to securities, but M2M (in my opinion) gained in popularity as a practice, and eventually became an accounting rule, because many people wanted to recognize asset appreciation from the real estate bubble prior to sale . . .”
But my core objection to M2M is that if a company is overvaluing its assets, you don’t need an outside market valuation to determine that fact, the proof of the pudding will be in the cash flow. Why do you need an outside market to tell you what an asset is worth, when you can see how much the company’s assets are yielding simply by looking at their cash flow?
Obviously this is too simplistic, but I think historical-cost accounting is simple and hard to fiddle, and if the historical-cost number is wildly overvalued, then that fact will show up in the company’s cash flow anyway, so what do we need M2M for?
April 3rd, 2009 at 4:10 pm
No, that’s not how Keynes meant the term.
April 3rd, 2009 at 4:12 pm
Nassim Taleb nailed it on CNBC the other day: mark to market is responsible for banks’ problems the way a thermometer is responsible for a fever. Furthermore, creating more opacity in the banks is counterproductive. Relaxing standards and injecting more leverage into the system via the Geithner put will not restore our financial world to the way it was before the crash. Krugman is right – there is no going back. That system was simply unsustainable.
April 3rd, 2009 at 4:27 pm
M2M is not a good idea, because for assets where there is intention to hold them for a long time, day to day, or even year to year, fluctuations in the value of the asset should not have impact on your available equity. M2M allows people to access equity during booms they should not be able to access.
Also, I think he did intend that those Animal Spirits do have an element of irrationality.
April 3rd, 2009 at 4:31 pm
Here’s the analogy: She’s got syphilis, we all know she’s got syphilis, She starts telling us it’s a summer cold, I’m still not getting into bed with her
April 3rd, 2009 at 4:49 pm
M2M is pretty new, how did banks and bank investors get by without it?
The current crises seems to be finally exposing the real problem. Both the Left and the Right share this problem. It is this FAITH that markets are always perfect. That information is processed perfectly and instantaneously. Deregulation was built on that faith. M2M is built on that faith. 20 years from now, economists will write papers on how we were so silly.
When can we show that this faith in market prices is nothing more than faith? When do we stop ignoring the abundant empirical evidence that markets can and frequently do break down. We need a new regulatory framework, not because the other one wasn’t working, but because it couldn’t work. It was based on the idea that the market knows all and always works perfectly to set prices.
This faith in “the market” has been economically akin to plugging our defense grid into SkyNet.
April 3rd, 2009 at 4:49 pm
The internet is a wonderful thing. It allows totally unqualified people to opine about things of which they know virtually nothing.
Matt, you are a good kid, but M2M is a very complicated issue. To present it as a good-bad thing in which opponents are trying to hide losses shows a lack of sophistication. Nothing wrong with not knowing about complicated matters — heck, I only know because I wound up in the securitization industry by chance some years ago — but don’t try to pretend.
M2M can inflate profits but it can also irrationally force writedowns.
If the day-to-day market price of a security for which a bondholder will eventually recover 95 cents on the dollar is 50 cents on the dollar, how should it be marked? M2M would force institutions to write it down to 50 cents, but why would that be rational if it is held to maturity?
April 3rd, 2009 at 5:21 pm
edit, allow me to stand in for MY as Designated Well-Intentioned Simpleton: If the most anybody will pay for that bond is 50 cents, does not that suggest people don’t believe it will eventually pay off 95 cents? Why would they think that unless they have reasons?
April 3rd, 2009 at 5:44 pm
I didn’t realize that rich bankers worked on Capitol Hill and were named Barney Frank and Paul Kanjorski.
Guys…The ship has already sailed. People (with this exception of this buffoon) figured out that mark-to-market was an unbridled disaster.
Again, any of you that own a home, are you judged to be insolvent because you can’t pay off the balance of your mortgage today? Of course not…because you can service your debt.
These banks can service this debt as well. Why the hell would we treat a bank as insolvent that doesn’t have a problem servicing it’s debt in a piss poor market.
Mark to market was a big reason why this whole mess got so far out of control. It does nothing for transparency, and it certainly didn’t do anything for our economy. The alternative (letting markets figure this out) was ALWAYS better.
This guy is a moron.
April 3rd, 2009 at 5:48 pm
And just as I expected…The expert on financial markets at CAP is a lawyer…WITH NO EXPERIENCE WORKING AT A BANK.
His experience was working on Capitol Hill. As some of us who have actually worked up there can attest to…Lawyers on Capitol Hill that don’t work solely on the law tend to be morons.
Guess the memo came down to promote this guy. Really, really pathetic.
April 3rd, 2009 at 5:51 pm
F]Gang
As edit says it is a complicated issue but one which is hardly new. A bit of background.
Banks had always used m2m for certain types of assets i.e. assets that were to be held in a trading book and valued daily Loans on the other hand were never marked but were considered assets hat were to be held to maturity. The problem is that in modern banking there are not such clear distinctions and the securitization of what start out to be loan assets on the basis that they are more easily distributable in that form raises the question of accounting treatment. Another thing: the syndication of pure loans also muddies the waters because how a bank in a syndicate views a loan may determine how ALL the banks view the loan. If there is an active market for all of these things m2m is a fine way to handle the situation, but when markets become impaired or as was the case in 1997 and last year, disappear, how does one “Value” all these different types of instruments. I wont even get into synthetics and the problems caused there. The change in treatment this week was sorely needed…had FASB moved earlier they might have saved the taxpayers a trillion or so
April 3rd, 2009 at 5:51 pm
No, that’s not how Keynes meant the term.
Econobuzz, if inflation expections become unanchored or untethered, is this due to the aforementioned “animal spirits”?
April 3rd, 2009 at 6:00 pm
Hank Greenberg wants mark to market to ease.
April 3rd, 2009 at 6:13 pm
anon
what is it that Hank wants?
April 3rd, 2009 at 6:57 pm
While reasonable folks may disagree, I believe that what Keynes originally meant by “animal spirits” did not at all imply irrationality — nor by extension “unanchored” or “untethered.” I don’t think any of the behavior we have witnessed over the last several years falls into the category of “irrational.” Greedy, potentially destructive, doomed to eventually fail for many, yes; irrational, no.
I tend to think that people behave rationally most, if not all, the time. That may not conform to what some economists define as “rational” but, for me, that calls into question their definition.
But I may not understand your question.
April 3rd, 2009 at 8:21 pm
Ed Smithe,
i don’t think you read the piece. if you had, you’d probably have seen that the article’s central claims are: 1) mark to market impacts are overstated, because banks can opt out in many ways under the accounting rules; and 2) that the issue of solvency is determined by regulators, not by the accounting rules, and so this decision to decide upon regulatory forbearance (which is much more contentious and complicated than your simplistic claims would suggest) should be made by the banking regulators and not through accounting rule changes, which are intended for investor consumption.
Also, your claims about bank solvency kind of ignore the fact that credit default rates are soaring, not slowing, which kind of puts the lie into the “we want to value our credit assets at $0.95 on the dollar” claim, doesn’t it? i mean, people were claiming back in December 2007 that the markets were overreacting then as well, and we all know how that turned out.
April 3rd, 2009 at 8:50 pm
FASB does not stand for FEDERAL Accounting Standards Board.
It stands for FINANCIAL Accounting Standards Board.
The difference is important.
The FASB is not a government organization.
It is a voluntary, private organization.
However, the SEC adheres to its standards, etc., in enforcing the law.
April 3rd, 2009 at 8:52 pm
the Simpson’s episode where Sideshow Bob explains his tattoo “Die Bart Die” by explaining “It’s German for `Die Bart Die’”
Actually, he explained that it’s “the Bart the”.
April 3rd, 2009 at 9:27 pm
The enthusiasm for “mark-to-market” accounting reminds me of the Simpson’s episode where Sideshow Bob explains his tattoo “Die Bart Die” by explaining “It’s German for `Die Bart Die’”.
I think you meant to say:
The enthusiasm for “mark-to-market” accounting reminds me of the Simpson’s episode where Sideshow Bob explains his tattoo “Die Bart Die” by explaining “It’s German for `The Bart The’”.
April 3rd, 2009 at 10:13 pm
Another moron,
I think that the proof is in the pudding so to speak. When the market dried up for these assets, banks were forced to mark them down…Could you explain to me just how you would value assets like these when there are no buyers?
As to your point…that banks had more leeway…tell that to Citigroup. I think they might disagree with you on that point.
As a result of the mark downs these banks got massacred by credit agencies — which made it far more difficult (read expensive) for them to do business.
So no, I don’t agree that this is anymore complicated than that…and in fact, I would venture to say, based upon my conversations with people that actually understand this, that I’ve got it (albeit dumbed down) right.
Lawyers with no experience running banks don’t understand this. It’s because of lawyers and accountants that this thing go so out of control in the first place.
What’s most amusing is the irony of it all. Here’s a think tank that puts a guy with no real experience in finance in a position such as this to educate us all on…finance.
Like any lawyer, he’s great at writing and analyzing law (especially when it comes to regulations). Nothing more, nothing less.
April 4th, 2009 at 10:05 am
Ed,
Citi has been lambasted for holding onto embedded losses for too long, they only just took a bunch of MTM writedowns last quarter, and most analysts think they are holding onto hundreds of billions in unrecognized CREDIT losses, forget about MTM losses. So yeah, I think Citi’s a pretty good example of how FASB rules give banks a lot of leeway in avoiding MTM. Or are you really trying to argue that Citi’s losses are OVERstated? If so, that’s hilarious, and I wish you good luck in going long on them.
You are conflating between MTM and the question of bank capital and loss recognition. You are arguing that MTM doesn’t reflect real credit losses. But that doesn’t matter, because you’re talking about this in terms of insolvency, which is a bank regulator matter. Even if you are right (and most independent investors and policy folks disagree with you- Krugman, Talleb, Roubini, etc. aka all the folks who were right about the extent of this credit crisis- remember the predictions earlier this month that we’d see another $2T+ in losses? Those weren’t MTM losses, they were predicted CREDIT losses), you’re misunderstanding the role of MTM accounting. Regulators have considerable flexibility to do capital forbearance, and there’s a pretty good history of that. Accounting is for investors, not regulators.
Investors are going to look at these mark-to-make believe numbers and you’ll see the smart money continue to stay on the sidelines. This is a very Japan-like move we’re making.
April 4th, 2009 at 3:39 pm
This is perfect.
Certain high-finance hucksters (and their paid lackeys in the conservative media) have long despised mark-to-market, because it puts a crimp in their Enron-style scams.
Just as the elimination of mark-to-market would have meant that banks can pretend their assets are worth more than they really are, the adoption of regulatory forbearance by Congress, and this minor tweak by the FASB, means that certain political activists can pretend that mark-to-market has been eliminated.