Mark to Market is an incendiary accounting topic, mainly due to the abuses as expressed in the much noted and documented history of Enron. Even now (three years into a recovery), we are living through one of the most difficult economies here in the States, almost in living memory – that is, you have to be a Centenarian to actually have witnessed the depression and understood at the time, the full implications of what was going on. Without going into lengthy comparisons to the 1930s, a few things are clear. Both markets then and now involved the suspense of rationale. Both involved excessive debt (mortgage in the latter case, stock margins in the former), runaway markets, and ultimately a banking crisis. Oddly enough, the origins of suspending Mark to Market Accounting were in 1938, “the destructiveness of mark-to-market — which was in force before the Great Depression — is why FDR suspended it in 1938.” The reasoning behind this statement is that “when banks or insurers write down the value of their assets they have to get new capital” [due to capitalization ratios required by bank regulators] (Forbes, 2009). In other words, according to Steve Forbes, banks that were in a fair cash position were forced to act in ways that hurt them materially due to the law reinstated in 2007.
The problem is that suspending such rules often is as odds with the truth. For example, when a bank makes a home loan, it is considered an asset to the bank, with the home itself backing the loan with a lien. This is not a problem until thousands of these loans were bundled together into very sophisticated investments that was bought and sold with the highest ratings possible with complete disregard for their underlying quality – even up to the very end of 2008. Again, this is a complicated, but just one example of how truth and good judgment was suspended. The answer to this was not an easy accounting equation, but it illustrates the importance of truthfulness in the asset-measurement concept (Breitner and Anthony, 2010, pp. 8-9), conservatism (pp. 47-48) and the guiding principal of ethics. What is interesting is that many of these concepts can be used for good or bad depending on the intention of those manipulating the numbers.
References:
Anthony, R. & Breitner, L. (2010). Core Concepts of Accounting (10th Edition). Upper Saddle River, NJ: Pearson Prentice Hall Publisher.
Forbes, S. (2009, March 6). Obama Repeats Bush’s Worst Market Mistakes. Wall Street Journal. Retrieved July 21, 2010 from http://online.wsj.com/article/SB123630304198047321.html