Everyone is having a hard time finding financing in this economy. But what’s not clear is exactly why that’s happening and why it’s worse than it should be. The culprit is mark-to-market accounting.
Mark-to-market accounting is the practice of assigning value to
an asset (like a house) based on the fair market price of similar
assets currently being sold. It has been a part of U.S. Generally
Accepted Accounting Principles, a “common law”
pronouncement under the federal government’s Securities and
Exchange Commission and the Public Company Accounting Oversight
Board, since the 1990s.
In a liquid market — one where assets can be sold without
significant loss of value and buyers are readily available —
this kind of accounting makes sense. But liquidity isn’t a
constant. When we have the opposite — an illiquid market
— mark-to-market accounting serves to devastate an already
Imagine a bank. In an illiquid market, it is holding a lot of
assets that it is unable to sell, and the agreed-upon value of
these things drops because buyers are not available. These assets
can be real estate, packages of loans, mortgages, etc.
Even though this bank may have exactly the same assets as
before, it must report a decline in capital. That’s called an
unrealized loss. The bank’s lenders, such as investors and
the Federal Reserve, then will not allow it to borrow as much as
before based on the lower capital. Therefore, its customers
can’t get loans. There goes the new pool.
Consumers can’t borrow, so they can’t spend. Values
go down on already existing products because assets can’t be
sold, and the whole process becomes a vicious cycle. Mark-to-market
accounting is simply inapplicable to the kind of market we’re
in now, but there isn’t much of an alternative.
One exception exists in accounting law: A public accounting firm
can agree to vouch for a higher value of a company’s assets,
even if they’ve been artificially reduced by outside
circumstances. That’s helpful, in theory. The reality is,
this rarely happens. These accounting firms become liable once they
offer an opinion, and therefore are hesitant and quite conservative
in this process. It’s a false fix.
This kind of unhelpful legislation is the fault of those in
government who do not understand the full ramifications of these
silly accounting laws. To me, that is nothing short of reckless.
You could compare it to the recent pool legislation introduced by
lawmakers unfamiliar with our industry. This arbitrary idea of
mark-to-market accounting is what caused the Lehman Brothers
collapse, the largest bankruptcy in corporate history which, in my
opinion, could have been avoided without a government bailout.
Mark-to-market accounting most likely will be reevaluated and
fixed — but not until this current crisis is behind us.
The politicians charged with that task don’t want to give
this topic any more attention than is necessary until it is out of
people’s minds. The logical solution: limit liability for
public accountants, creating a real exception for an illiquid
situation where mark-to-market accounting can be devastating. There
must be new parameters for attributing value, whether positively or
So how does our industry help this along? We must educate
ourselves. Track down people with educated opinions, availing
yourself with a wide spectrum of knowledge. Inform yourself and
share those opinions with others. Instead of more government
intrusion, an educated public will demand real solutions. And that
will lead to greater economic growth.