More on Mark-to-Market Fallout

Accounting is supposed to make business and our economy work better. It should be used as a tool for providing a clear, accurate picture of how well or poorly a business is doing. It’s not supposed to be a weapon that unreasonably destroys businesses that do not deserve destruction.

But that’s what’s happened with mark-to-market accounting regulations.

Following are links to some recent sober assessments of the mark-to-market mess. Each one is worth reading to get a full picture of the negative fallout from mark-to-market.

First, Wall Street Journal columnist Holman W. Jenkins, Jr. wrote a piece titled “Mark to Mayhem?” in the October 1 Journal. He lays out much of the problem, and writes:

Accounting straddles the real and unreal, so it's hard to guess how much difference getting rid of mark-to-market might really make. The only way to find out is to try.

A mere accounting rule change won't reduce foreclosures or raise home prices -- then again, if spared drastic writedowns, banks might be more willing to lend, raising home prices and reducing foreclosures.

A mere accounting rule can't alter the underlying economics of a lending business -- then again, no longer worried about insolvency-by-accountant, investors might discover new confidence to inject capital and improve the underlying economics of a lending business.

No accounting rule is worth $700 billion. Then again, the essence of the Paulson plan was to raise the value of bank assets to help banks escape the regulatory equity trap. Does that mean we can change an accounting rule and save Congress from having to appropriate $700 billion?

Let's find out.

Second, former Dallas Federal Reserve Governor Robert McTeer penned an excellent piece for Forbes magazine. “Why Mark to Market?” appears on his blog, and opens: “I was afraid of accounting in school; I still am. Back then, I feared it would wreck my grade point average; today, I fear it will wreck our financial system.”

Third, also in the October 1 Wall Street Journal, economist Brian Wesbury does an excellent job at walking through the damage wrought by mark-to-market accounting, and taking on the arguments opposed to relaxing these rules. In “How to Start the Healing Now,” Wesbury explains:

Mark-to-market accounting causes so much mayhem because it forces financial firms to treat all potential losses as if they were cash losses. Even if the firm does not sell at the excessively low price, and even if the net present value of current cash flows of these assets is above the market price, the firm must run the loss through its capital account. If the loss is large enough, then the firm can find itself in violation of capital requirements. This, in turn, makes it vulnerable to closure, nationalization or forced sale.

If government is serious about fixing the current mess, then booting unreasonable mark-to-market accounting regulations is vital.

Raymond J. Keating
Chief Economist
Small Business & Entrepreneurship Council