Why mark to market for asset valuations?

Mark to market accounting, which forces firms to revalue their assets to current market values even when the market is frozen or dysfunctional, and even when the assets could be held to maturity and redeemed at face value, could be the prime suspect in the downward spiral of our credit markets, says Bob McTeer, a distinguished fellow with the National Center for Policy Analysis.

For example, if a bank loan goes into default, it makes sense to write it off the books. However, if a security trades lower because market interest rates have risen or because of problems in the market itself, requiring an immediate write-down is unduly harsh, continues McTeer.

Since capital is usually, and legitimately, a small percentage of assets, it can easily go to zero and a perfectly sound institution can be declared insolvent and taken over by its insurer or some other government agencies:

"Prompt corrective action" also makes the matter worse by allowing the authorities to pull the trigger before capital reaches zero.

Its purpose is to reduce the cost of "resolving" (taking over) troubled institutions, but what it amounts to is shooting the sick and wounded to expedite the burial.

Efficiency and cost effectiveness trumps fairness.

Mark to market rules and strict ratings may be appropriate (though unfair) in the good times as a means of preparing institutions for the bad times, but that doesn't mean they should be rigidly applied or even tightened up during the bad times.

However, critics of some mild regulatory forbearance will no doubt cite transparency as essential, but the two can go together, says McTeer.

It is time for common sense to come before accounting purity and cut our losses. It's one thing to become a victim of a bad loan or a bad company. It's quite another thing to become a victim of unnecessarily strict accounting rules, concludes McTeer.

Source: Bob McTeer, Why Mark to Market? Forbes, September 15, 2008.

For text: http://www.forbes.com/opinions/2008/09/15/accounting-market-capital-oped-cx_bm_0915mcteer.html

For more on Economic Issues: http://www.ncpa.org/sub/dpd/index.php?Article_Category=17

FMF Policy Bulletin/ 23 September 2008