End of Mark to Market?

March 11, 2009 at 4:18 am Leave a comment

Many in the financial industry claim that mark-to-market accounting has been a major contributor to liquidity problems plaguing the banking system.  On Thursday, House begins debates on a possible suspension of this rule.

So, what is mark-to-market accounting?  This simply means that bank’s (or any other business’, for that matter) assets are determined by their fair market value.  This seems simple enough, but what happens if the market for much of these assets has stopped functioning, as is the case for mortgage-backed securities?  It means that these securities should be reported at nearly zero prices, which dramatically drags down the balance sheet, and forces the bank to report huge losses.  Having smaller capital also negatively affects bank’s ability to lend.

This is not to say that mark-to-market rule is solely responsible for this crisis, but it could well have added fuel to it.  In fact, there is a train of thought that suggests that mark-to-market amplifies boom-and-bust cycles by overstating “real” assets, whatever they might be, during the good times, and understating them during the bad.

Suspension of mark-to-market rule will instantaneously bring banks’ balance sheets to much better shape, and it could be a huge boon to the stock market.

For basic explanation of mark-to-market, take a look at this video.

Entry filed under: Market Conditions.

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Leon Shirman's long-term investment philosophy is summarized in his book, “42 Rules for Sensible Investing”, also available from Amazon.


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