Is Mark to Market Crippling the Economy?
December 31, 2008 by Lela Davidson
Filed under Finance
Mark to market, or fair value accounting is the process of restating assets on the balance sheet reflect their current market value. The accounting rule has gotten a lot of attention lately because of its role in the current financial crisis. The rules have been amended, but the controversy continues.
What on the surface seems like a fairly straight forward rule has many implications. At the forefront now is the fact that financial institutions have had to recognize (take a hit) for billions on (devalued) mortgage-related securities because of the rule. Most economists agree that mark to market accounting has at least exacerbated the problem, if not flat out caused it.
Alex Dumortier at Motley Fool put it well:
You know you’re in a financial crisis when a technical accounting rule becomes front-page news.
Dumortier also does a great job explaining some of the finer points of mark to market.
William M. Isaac at the American Spectator has got a whole series on how mark to market accounting is the major cause of our current economic situation. I encourage you to read up on the subject.
I’m no econ genius, so enlighten me if you can. It’s hard for me to understand how the way we describe something in the financial statements can really be the cause of all this turmoil. Seems to me if the underlying assets are really worth something, the books will even out next year, right? The accountants may be responsible for the rule, but not the leveraged economy it attempts to
represent fairly.
If our markets are really that fragile, then there’s something fundamentally wrong.
HI Lela, I know less econ than you, so I’m guessing here, but I think that there is a domino effect that when the banks lower the value of assets they have to increase reserves, which would have set up a vicious circle.
But I believe that what people really need to understand is not what the financial institutions did, since we really don’t have much control on stopping them from doing something similar in the future, but what they personally need to do to put their own house in order.
None of us can control what others, especially others doing esoteric financial transactions, do when we, and worse they, don’t really understand them.
So we need to act where we do have control and that is ourselves—although it’s much more comfortable to have others shoulder the responsibility:)
I partly agree with Miki’s analysis. We, as individuals, need to rethink the way we spend and save. There is too much artificial wealth in the United States. You have people that drive a Benz and live in a $500,000 home yet make $70,000 (or less) a year and have $100,000 in credit card debt. That’s not wealth. Not only do individuals need to rethink the way they spend and save, but our government needs to do the same. Our nation is artificially wealthy in the same manner that our people are. We all need to wise up and we need to do it fast.
Aleksanedar, the only problem I see in your example is the credit card debt.
Home value is a function of supply and demand, so I don’t judge homes based on dollar cost. $500K barely buys a tract type starter home in the Bay Area, but it buys a mini mansion where I live now. And I see no problem owning a Mercedes if that is what you want.
I still believe that if each of us cleaned up our OWN act in our OWN way then part of the problem wold be solved.
My apologies, but I am tired of sweeping statements that people can nod sagely over, but believe don’t apply to them because the numbers in the examples are so high.
Personal financial management should be a required course in high school, but that isn’t going to happen any time soon.
Short term thinking has been the motto for our ‘leaders’ in government, business and religious roles, so why would you expect anything different in individuals?
Well, we can agree to disagree then.We can do that sometimes :-) Let me say this Miki: I, by no means, am perfect. I’ve been just as fiscally irresponsible as many others out there.My point is that there is a HUGE problem in buying a Mercedes IF you can’t afford it. Same with a $500k house (just a random number – pick $200k or even less if you would like). This goes for other items too. If you can’t afford it, you shouldn’t buy it. And, the same applies to government.We are in the situation we are in today (partly)because of artificial wealth. People, including myself, over extended themselves (this includes with credit cards) and made purchases on the premis of wealth that wasn’t truly there. All I’m doing is stating what I’ve learned through experience – cause I’ve been there and done that too. And, its not good for us as individuals and its not good for our nation.We can’t afford to just continue to borrow more and more money. Makes no sense (at least to me).
Aleksandar, I’m not saying the borrowing is smart or the right way to handle things. But for the last several generations people have been taught by example to look at the payments and if they could make them based on BEST case analysis then it was OK to buy whatever.
But bad as “our” fiscal responsibility is, “theirs” is far worse. ‘Theirs’ being our political and business so-called leaders. And ‘us’ or ‘them’, practically nobody does worst case analysis these days and when it is done no one wants to listen.
Yes, in a perfect world individuals would be financially literate and fiscally responsible, but we’re a long way from perfect. People follow the leaders and the leaders are fiscally irresponsible.
So what do you fix first, the chicken or the egg?