Tuesday, February 24, 2009

Suspend Mark-to-Market Accounting

As our government continues to print & spend trillions of dollars to resuscitate the ailing US economy, their time & energy would be better served by simply suspending or modifying mark-to-market accounting.

What is mark-to-market accounting? It is an accounting methodology of assigning a value to a position held in a financial instrument based on the current market price for the instrument or similar instruments. For example, the final value of a futures contract that expires in 9 months will not be known until it expires. If it is marked to market, for accounting purposes it is assigned the value that it would currently fetch in the open market.

This definition seems very logical, but in my opinion does NOT apply to all assets. For example, if you had to sell your home on a Tuesday and didn't receive any offers, you would have to mark down the value of the asset the next day due to lack of offers the previous day. Some assets are simply not as liquid as others and should be priced in a different manner. How they should be priced is open to debate.

A brief look at history: Mark-to-market accounting existed during the Great Depression and many economists feel was the culprit for many bank failures at the time. Franklin Roosevelt suspended it in 1938 and the rule didn't exist until again until FASB 157 brought it back in 2007 (largely due to the Enron debacle and 'off balance sheet' assets). How is it we had no panics or depressions for 70 years and now we're dealing with a financial crisis?

First Trust Economist Brian Westbury succinctly described the benefits of suspending mark-to-market accounting. He states, 'both time & growth are absolutely essential when fixing financial problems. Time to work things out and growth to make working those things out easier. Mark-to-market accounting takes both of these away."

1 comment:

TomJ said...

Well said! It makes no sense to mark down performing, long-term, illiquid assets. There’s a double whammy taking place – Banks have to mark down the assets and increase the reserves for those assets at the same time, both of which affect the Banks balance sheet and liquidity.