Mark to market accounting

There’s been a fair amount of talk about the problem with the “mark to market” accounting rule lately and how it’s contributing to the financial downturn. Wondering what “mark to market” accounting is? Whatever you do, don’t listen to the Economics professor who tried to explain it on NPR this morning.

I'm no economist but I did stay at a Holiday Inn Express last night so let me explain it in stupidhead terms. If I can understand this thing, anyone can.

Let’s say you’re a bank. You have an asset sheety where you keep track of all the shit that’s worth a thing. This is one of the ways you—and others—assess how financially healthy you are. Banks with lots of assets are pretty healthy. Banks with fewer assets = less healthy. More importantly, banks with assets on the decline = in trouble.

With the idea of that asset sheet’s health in mind, enter the mark to market accounting rule. This rule helps define a certain value to your assets. Under mark to market accounting, the value of your asset is the amount that you could get for the asset in the current market.

Step into today’s economy. You’re still the bank. (Remember: that’s how this started moneybags.) One of your assets is your real estate holdings (there are other assets affected by mark to market but I'll stick with real estate for this example) that you own as collateral for mortgages. So let’s say that in October 2007, your real estate holdings were 100 million. By mid-2008, real estate was tanking so now your real estate asset was worth 70 million. Ugh. Bad half a year.

But things suddenly got a lot worse in September—the sub-prime mortgage mess is in full effect and the bottom drops out of real estate, which again fucks your asset sheet…not slowly but immediately. The panic in real estate has an immediate and fucking effect on your balance sheet and in 1 week, your balance sheet is valued at 50 million.

Now you’re a bank with a certain asset with a value that halved in a year. Banks need—MUST HAVE—good balance sheets, i.e., lots of assets. If you don't, people pull all their money (just like the run in It's a Wonderful Life)



and then you have no cash and you're kaput. So what do you do? You have to hoard cash instead of loaning it out so that you have more assets.

This is awful though! Hoarding cash means that you as bank won’t be making money on loans (that's how you make money as a bank but you knew that). Not loaning people money means that companies don’t have money to pay employees, make improvements, and otherwise turn the wheel of the economy. (This is the "credit crunch" everyone's talking about.)

So what’s the problem with mark to market accounting? Mark to market accounting destroys a bank’s asset sheet in a hurry when a panic occurs—which incites even more panic.

The proposed panacea for “mark to market” accounting would allow banks to value their assets not based on their value in the market, but some value that is not panic-inspired. So let’s say the bank looks at it’s real estate collateral and says, “The panic will end and the real value of this real estate is 80 million, which is what it will be valued again in the near future.” This helps the bank’s asset sheet and doesn’t feed the panic spiral.

If you’re still with me, you perceive the problem with this too. It gives the bank a lot of leeway to voodoo the asset values to something other than their market values. This sort of voodoo undermines confidence in banks’ ability to value assets, which could cause other problems and is the reason mark to market accounting went into effect in the first place.

Suspension of the mark to market rule should have a good effect immediately on balance sheets, driving up the values of banks' assets overnight. The immediate result will be banks having more assets. With more assets on paper, banks don't have to hoard so much cash. What do banks do with excess cash? Loan it out--that's right. This gets cash flowing into the economy and it's not a loan from the US taxpayer. Changing the mark to market rule is undoubtedly a faster and more market-friendly way to start money flowing into the economy than the 700 billion dollar rescue nee bailout plan, which will take a lot longer to get going.

Any other questions class?