Marking to market would cause a TU condition in the financial markets and bankrupt governments of any overleveraged parties, but we'd all come out better and more honest on the other side.
I have a close friend who is in bankruptcy right now.
The reason that the pain of bankruptcy is limited, is because the government steps in and keeps you from getting completely crushed by the effects of your own mistakes.
That's what the government was trying to do by backing some of Bear Sterns assets, but they weren't really doing it for Bear Stearns. They were doing it because they were worried about a complete collapse by Bear Sterns might cause people to pull their money out of investment banks on a huge scale. Not just Bear Sterns, but all investment banks.
If there's a run on banks, we end up with another great depression. The Fed is trying to instead soften the blow caused by people's overzealous risk taking, and tone down the effects to stagnation or a short recession, rather than a repeat of the great depression.
What the fed is doing kind of resembles how the government protects you during bankruptcy.