Mark-to-Market Rules

By Professor Jeffrey Frankel, Harvard University

By Professor Jeffrey Frankel, Harvard University

Back in September 2008, I had more time on my hands.  I was unemployed, and the whole economy implosion had started to really hit the airwaves.  When I wanted to research the issues on how we got here and what to immediately focus on, I had heard these words: Commercial Paper, Mark-to-Market Rule and Nationalization of the Banking Industry.  I was told not to look at the Dow, but to look at the VIX index for a more accurate picture.  Me being SUCH the non-financial type, I had more questions than knowledge about these things.  And now, these words seem to be popping up again.

Credit.  Or lack thereof.  Has anyone seen that Hyundai commercial that says “If you lose your job this year, you can return your new car to us without hurting your credit rating?”  Wow.  I was flabbergasted when I heard that.  It’s a great marketing plan.  Addressing today’s concerns by speaking plainly and calmly about them.  No more p*ssyfooting around it.  Plain and simple; we know you’re concerned, but come to us anyways – we have a plan for you.  Buy our product, and we’ve thought of an “exit strategy” for you, if things don’t work out.  Very, very smart.

This credit freeze, if you will, is due partly because the banks do not know who has bleeding balance sheets, or to be more accurate, who is bleeding worse then them.  This is a different issue from those people who have defaulted on their loans (those people I will put under the “housing crisis” bucket).   No, I am speaking about the financial industries’ P&L sheets. No one knows how many toxic assets they hold.  Why is that such a mystery?  Because of deregulation, no one was really looking at their risk portfolios; the government allowed them to leverage 30:1  (That would be like you making $1000 a year but taking out a loan of $30,000 – thanks Chris Desbar…)  Not a great idea in hindsight.

Bankers and investors went crazy with mortgage-backed securites (uh, not so secure actually), and fast forward to today.  Now the banks are left with more debt on their balance sheets then before.  Now, Wall Street wants to suspend the mark-to-market rules. I can understand why, if the asset is not truly known what the value is, then why would you want to guess how low it is?  If you invested last year $100, and now the value is somewhere between $40-70, why would you claim any number that isn’t verified?  You wouldn’t,  hence all the fuzziness around what exactly is on the books.

But, to me, my gut is saying this is a bad idea.  The mark-to-market rules were put in place after the Great Depression to keep the right accounting rules in place.  Mark-to-market rules broadly states that you must account for todays’ value of the asset, not the amount of money you paid for that asset.  (Click here for wikipedia’s definition)

If you wanted to suspend the rule, wouldn’t that be akin to “mark-to-make believe”? Doesn’t that seem a little fishy, simliar to the shenanigans we’ve see from Wall Street for the past few decades (to say the least?).  Something doesn’t seem right with that to me.

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