Warning: if Accounting isn’t your language of choice, your eyes may be about to glaze over. However, as with many things arcane, mark-to-market accounting may be having a huge impact on the world we live in right now, and according to many critics, could well be one of the root causes of the current financial crisis. Mark-to-Market accounting is a reporting rule that requires financial institutions to value their current investments at today’s value, even if they have no intention of selling those assets now, or anytime in the foreseeable future.
As an example, if you were to consider the current value of your own 401k, which most of us are already doing with some significant trepidation, you’re likely down about 50% from the highs of 2 years ago. However, you’re able to do the calculations and realize that so long as you don’t sell today, you’ve still got a chance to recover on the long haul. Mark to Market doesn’t allow banks that option, but instead forces them to report the values on their holdings at todays value, as if they were going to sell everything today.
Because banks are not allowed to lend every dime they have access to, but must hold a portion back to cover their loans (see fractional lending), some argue that an accounting rule that ties asset value to current valuations, rather than allowing them to take a longterm view, much as we would, places artificial restrictions on their ability to recover from market fluctuations, and is at least partially responsible for the current liquidity problems in the world financial system.
The other side of the argument says that banks, whose actions with risky assets have largely brought this crisis on themselves, should not be allowed to price their asset valuations at anything other than current market value. Allowing them to do so essentially is seen by some analysts as rewarding the irresponsible behavior that started the initial cascade, and passing the risk on to the taxpayers.
Ultimately, the question of mark to market accounting will be coming to congress in the not so distant future. Legislation being what it is, we’ll have to see what comes of this, and whether our current administration decides to address it as an accounting problem, or a consumer protection issue.