Investment Intelligence When it REALLY Matters.
Mark-to-Market Isn't the Problem
It seems as if many have been fooled by those supporting the banks. The general argument that has been made is that mark-to-market accounting has been largely responsible for the banking mess since it creates price transparency for assets held on the books daily.
Given the problems in real estate, mark-to-market has been particularly harmful to mortgage-backed securities. Therefore, as the argument continues, we should eliminate, suspend or revise mark-to-market rules because the price transparency it offers is not necessarily indicative of asset values. Finally, removing mark-to-market would help rescue the banks. I challenge these views.
The fact is that mark-to-market accounting provides a vital function. It allows investors to know what the assets would sell for currently. Thus, this price transparency implies asset valuation. What is valuation? You can use any traditional method you want, from discounting cash flows to the options pricing method.
At the end of the day, valuation ultimately relies upon a large market of buyers and sellers of securities. They are the ones who determine pricing. Hence, they are the ones who determine valuation. Valuation ultimately relies on what someone is willing to pay for a security. And mark-to-market better estimates valuation according to this definition.
We should not blame this prudent accounting regulation on banks that acted irresponsibly. Are we supposed to design rules around banks so they can continue their Ponzi schemes? I think not. The fact is that if banks had practiced real risk management instead of using highly flawed methods to model risk (like VaR), they would have contained and priced risk much better. This would have restricted the amount of leverage they used, and we would not be in this mess.
But they chose the path of optimal short-term profits instead, because they were focused on their Christmas bonuses. Greed, incompetence, and fraud. These three words sum up the reasons why the banks are in this predicament today. And unfortunately, virtually everyone around the globe is paying a heavy price for their mistakes. So don’t blame a responsible and beneficial accounting rule for the problems. Anyone who believes a removal of mark-to-market guidelines would be prudent simply isn’t thinking straight.
That said, I do believe a temporary revision to mark-to-market guidelines would add a large amount of intermediate-term stability to the banking system. But these effects would not necessarily be permanent. Such a change could actually create a larger problem down the road.
I might have been in favor of a change or halt in market-to-market accounting guidelines PRIOR to the banking bailouts, but not now. Revision or removal of mark-to-market would add more to the bailout precedent, further strengthening the moral hazard that has been created. As well, any such revisions intended to be short-term would most likely be drafted into permanent accounting rules. That would definitely create some very big problems down the road.
In conclusion, mark-to-market serves a vital function. We should not blame it for the banking problems. The bankers are to blame. We should never create rules to suit criminals, nor should we blame the law when criminals break it.