Make Fair Value Fair ( Mark to Market rules are ruining many viable companies )

The last time I looked I couldn't find mark-to-market accounting in the Constitution of United States. It must be the eleventh commandment because it's obviously sacred. I understand the President has the authority under the Emergency Powers Act, or some such legislation, to suspend the Bill of Rights in case of national emergency. Well, we have a national emergency, so mark to market must be more important than the Bill of Rights.

If a foreign power destroyed a fraction of the wealth that mark-to-market accounting has the past year, we'd go to war. I'm no accountant, but, as I understand it, mark to market is part of what they call "fair-value" accounting; it must be fair.

If so, I have couple of questions. What's fair about a financial institution being put out of business because small portion of its bundled assets become impaired and the whole bundle must be treated as a loss? How is it fair that an expected loss of a few thousand dollars a few years from now, in some cases, must be treated as loss of millions in the here and now? If a small number of mortgages behind mortgage-backed security become impaired, or potentially impaired, why must the whole bundle be written off? If I have a sack of apples with a couple of bad ones, throw the bad ones away -- not the whole sack.

More questions: If the "impairment" results from lack of liquidity because markets aren't working, why can't banks simply hold on to their securities -- until maturity if necessary? Why must they assume a fire sale at fire-sale prices for something they don't have to sell? If some of the impairment results from actual losses on the underlying mortgages, why can't they write off only that portion of the impairment?

There was a lot of corruption in the S&L debacle, but that is beside the point at issue here: the purpose of accounting rules is to give an accurate view of a company's value. If that value is skewed by accounting rules that produce unreliable valuations, then those who deal with the company are misled into bad credit and investing decisions.

Given a choice as a prospective lender or investor, would you prefer to lend or invest in a company whose value was calculated according to mark to market rules, or according to some more relaxed and opaque standard that produced an unreliable valuation? With a prudent regard for your money, you would tend to prefer mark to market valuations as being more reliable in a pinch.

Or, if you own a company that is conservatively managed and uses mark to market rules, you would justly feel penalized by seeing competitors getting credit and investment based on dodgy accounting. Worse, when credit contracts, you would tend to get punished along with the high flyers with less reliable books because the accounting rules do not make relevant distinctions in asset values.

Capital markets and sound accounting rules can be cruel, but it is to the good purpose of denying credit and investment to firms that are too risky to deserve it. Ultimately, loss of access to credit is what pushes many failing firms into bankruptcy. The result is that bad contracts, investments, and loans are written off and assets are reallocated to other companies that can employ them to better effect.

Consider the result if firms were required to report mark to market valuations as well as some more relaxed standard. The marketplace would inevitably look to mark to market numbers as being the sounder method of valuation. In effect, the argument against mark to market is an argument against more reliable accounting so that painful truths are not told.

You almost sound as if I'm advocating funky accounting in some situations. No such a thing.

I'm merely saying -- and I'll say it loud and long -- that mark-to-market is NOT a reasonable and/or acceptable way to value assets in a considerable number of business activities. That there is a crying need for an acceptable evaluation method in these industries is beyond arguing.

Attempting to mark ''to market'' the value of, say, a strip mall in a depressed area, on an immediate basis, is futile and self-deceiving and an exercise in time-wasting. Like as not, in any given day and/or week, there will be no bids for such a property or any comparable property. Therefore, mark-to-market is ludicrous, no more, no less.

To value such a property correctly (or, at least, as correctly as can be done), one is going to have to take a view over time; i.e. all the bids and transactions on comparable (or nearly so) properties within the area over a year or two or three, and concoct a sort of rolling moving average.

Now, this doesn't cure all ills, by any means. The resultant valuation is still going to be a rough one, but it's going to have at its base the real-world bids and transaction values. And, it's going to be a hell of a lot more accurate than an immediate mark-to-market valuation.

This fantasy that one can ''mark to market'' something that does not have a regular and freely traded market to begin with is so wrong-headed and so corrosive to proper conduct of business that it must be junked straightaway.

To answer your question directly: were I a lender or investor in, say, commercial real estate, would I prefer immediate mark-to-market or historical bid/offer data as a metric for the most accurate possible valuation of the real estate in question, I should vastly prefer -- without any hesitation -- the historical transaction record, assuming only that the data is sufficiently recent (say, w/in the past 6-12 months or closer).

Immediate mark-to-market is BS in these markets, and this is easily demonstrated. First, nothing worth the description as an ''asset'' can ever have a valuation of zero in normal circumstances (I exclude here things like brownfield properties, which, if their real-world value is in fact zero, this is due to exogenous circumstances such as lawsuits). Yet, we read every week about some company having had assets of one type or another marked at zero.

Second, pick a property, any property, in some state. Call every potential investor/lender in the state and ask ''What would you bid for this property if you were interested in it?'' Guess what? You won't get any data, because they won't tell you. Where's your ''market'' that you're ''marking to'', eh? No bids, no market. Pretty simple.

So, what's the mark-to-market value of the property? Zero? Can't be. The property is certainly worth something. What some accounting boffin says it is? Gag me with a shovel, puh-lease! What the goobermint says it is? That's worse still; gag me with a backhoe.

Like it or not (and I don't), in such situations as these, all you've got is approximation via historical transactions.

Write this down in big, black letters: Mark-to-market is meaningless or worse when there is no stated bid/offer market for the goods or property under discussion.

Wasn’t there talk on CNBC about an auction for the deriviatives, and haven’t many already become due? The hedge fund managers have had to anty up a lot of money to take care of those CDS’s and deriviative bets lately,,,but there are a lot of them still out there. I had thought they were going to get a majority of them out of the market...

I don’t know a lot of the answers for this, but the summary sounds plausible....my opinion is that betting on something should be done with integrity, and the money up front, and that would keep a lot of it from happening.

I read “Financial Armegeddon”, as it was a Christmas present, and it was very close to my own belief that the market would recover somewhat, but in six to ten years we will be right back where we were in Septemeber 08 if changes aren’t made. We need to prepare for some future problems in U. S., and the Horizon Project scientists are saying the same thing, although their “end of world” scenario in 2012 may not be completely accurate, as God is in control. I’ve heard others predict 8-10 yrs as the D-Day for complete meltdown if this market and economy is not fixed correctly. Time...eternity is swallowing up time.

Real estate is a different issue because values are based on appraisals derived from recorded sales. The usual (and disputed) application of mark to market is to stocks, mortgages, bonds, notes, and other debt and credit instruments that have ascertainable values in equity and credit markets.

Assume, for example, that a bank has a portfolio of loans that trade at a discount from nominal value. That being so, the value of those assets should be marked down on the bank's books. The bank then has to add to loan loss reserves, raise more capital, or be sold to a stronger bank.

Of course, when the general level of asset values in the market falls in a recession, there is a lot of pain to go around. But pretend accounting values for banks and financial companies does not eliminate the pain, it just disguises it and draws in new victims.

In the current crisis, the federal government is injecting capital, cheap credit, and new money into the banking system in order to prevent a freezeup of credit markets. Even so, the banks themselves do not yet trust their own or anyone else's balance sheets because, with business conditions still weakening, the markets have not yet cleared and found bottom.

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