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December 19, 2008
Mark to Market Rules
The attack on mark to market accounting rules has many friends. Under the rules banks must carry on their balance sheets liquid securities at fair market values. When bank derivatives lost value, banks had to recognize write offs -- "even though they were not selling" -- and the write offs threatened bank capital requirements--forcing banks to sell assets to generate cash--and causing more write offs as the distress value of the sold securities had to be reflected on the balance sheets of all the banks. Mark to market accounting applies only to liquid securities and does not apply to may classes of bank loans -- which are recorded at initial cost with reserves for potential losses. Many banks, even with mark to market accounting, are trading at prices that are below book value (or even tangible book value). This means that even with mark to market accounting, book value amounts do not represent, they exceed, market value. Those who attack mark to market accounting are barking up the wrong tree.
December 19, 2008 | Permalink
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Comments
The problem is not mark to market accounting, it is mark to market accounting in an illiquid market. Those who defend irrational accounting rules in favor of running a federal deficit into the trillions and nationalizing the problem are missing the point.
Posted by: brian | Dec 23, 2008 11:47:35 AM
Mark to market is shorthand for reporting based upon liquidation value rather than historical value, when a liquidation value is readily available.
Banks routinely trade both below and above book value, based on concerns like predicted future value of a particular bank due to its current management and economic trends. In an environment where market participants expect that the health of the finance sector of the economy will decline in the near to medium term future, share prices of banks should be below their current liquidation value.
Of course, another possible reason for banks to trade at below book value is the belief that the reserve accounting is deficient.
There is nothing inherently bad about historical prices and a reserve. Indeed, one could do mark to market valuation of securities on that basis perfectly easily (and probably conveying useful information). The problem is with how timely and accurate the reserve estimates are on the historically valued loans.
Figuring a reserve is particularly problematic when the underlying asset values that are driving the reserve prices, collateral values, are themselves off the books.
Posted by: ohwilleke | Jan 1, 2009 9:42:42 PM
