The Boring Mark-to-Market Discussion

Those who study accounting, or aspire to responsible positions in finance, learn of the importance of FASB early on. They had better, because FASB, the Financial Accounting Standards Board, is universally recognized as the authoritative voice in setting finance and accounting standards.

FASB is:
“A seven-member independent board consisting of accounting professionals who establish and communicate standards of financial accounting and reporting in the United States. FASB standards, known as generally accepted accounting principles (GAAP), govern the preparation of corporate financial reports and are recognized as authoritative by the Securities and Exchange Commission.

Accounting standards are crucial in an efficient market, as information must be transparent, credible and understandable. The FASB sets out to improve corporate accounting practices by enhancing guidelines set out for accounting reports, identifying and resolving issues in a timely manner and creating a uniform standard across the financial markets.”

“Mark-to-Market” is a term that describes one of FASB’s most important rules (FAS 157): mark-to-market accounting requires banks to value assets as if they were about to be sold on the open market. Unfortunately for banks holding mortgage-backed securities, the "open market" price of an unwanted asset is often lower than its cash flow value. This forces banks to show "losses on paper" even though the losses haven't been realized, and probably never will be.

To date, banks have written down hundreds of billions of dollars because of mark-to-market accounting, even though the mortgagee is paying on time and there is no indication he will not continue to do so.

Much has been made about the cascading effect of “mark-to-market” in turning a housing downturn into a catastrophic shutting down of credit markets and the failures of hundreds of huge and important financial institutions. Considerable pressure is now being brought to bear on Congress and FASB to loosen this rule.

There are also some very good reasons for the existence of “mark-to-market”: it is an consumer protection measure. Because corporations are required to report the current values of assets, investors can get a better sense of which firms are gaining and which firms are losing. The reality, though, is that mark-to-market accounting can make a bank's balance sheet appear weaker that it really is which then triggers the need capital infusions from the government and leads to heightened investor fear.

This is precisely the reason why banks like Citigroup and Bank of America have been battered by the stock market. Even though they're earning healthy interest on their respective mortgage-backed bond portfolios, banks are constantly having to markdown their portfolio's value.

Congress and other influential organizations are now holding hearings on “mark-to-market”, and the word investors are hearing is that something is finally going to be done about its corrosive effects as it is now stated and interpreted. What is not generally known is that, although the concept of “mark-to-market” has a long history, FAS 157 was issued in November, 2007 – just prior to the financial collapse we are now experiencing and which is being blamed on the nonfeasance of the Bush Administration.