September 30, 2008
Accountants to the rescue? Mark to market?
Posted by Usha Rodrigues

Since the collapse of Bailout 1.0, I've been wondering when critics would seize on mark-to-market accounting. It turns out that Newt Gingrich and Mark Cuban (never thought I'd use those two names in the same sentence) have been calling for a suspension of the rule. From Newt:

Mark-to-market accounting (also known as "fair value" accounting) means that companies must value the assets on their balance sheets based on the latest market indicators of the price that those assets could be sold for immediately. Under such a rule, declining housing prices don't just reduce the value of defaulting mortgages. They reduce the value of all mortgages and all mortgage-related securities because the housing collateral protecting them is worth less.

Moreover, when a company in financial distress begins fire sales of its assets to raise capital to meet regulatory requirements, the market-bottom prices it sells out for become the new standard for the valuation of all similar securities held by other companies under mark-to-market. This has begun a downward death spiral for financial companies large and small.

More foreclosures and home auctions continue to depress housing prices, further reducing the value of all mortgage-related securities. As capital values decline, firms must scramble to maintain the capital required by regulation. When they try to sell assets to raise that capital, the market values of those assets are driven down further. Under mark-to-market, the company must then mark down the value of all of its assets even more.

I'm not a tax gal. Anyone care to weigh in on this one? I know mark-to-market was the response to accounting hanky panky at Enron, WorldCom, et al. Was the cure worse than the disease?

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