Bad 'Ol Mark to Market

Reverse Leverage of Mark-to-Market Wrecks Banks
The world's banking system is caught in a vicious trap, with a forced sale of assets at one institution wiping out capital at others holding similar assets. Think of it as extraordinarily high reverse leverage. You can blame mark-to-market accounting, the advent of new indexes that supposedly track values of a wide range of assets, or a market mind-set that assumes every asset is part of a bank's trading book.

Like the old Pac-Man character, this combination is devouring financial institution capital at a voracious rate. The question is whether it will gobble up even the new capital injections into banks by the U.S. and foreign governments. It's way past time to suspend mark-to-market accounting -- or somehow to make investors and analysts understand that fire- sale transactions aren't supposed to be having such broad implications.

Of course, suspending mark-to-market would be greeted by screams of outrage by its devotees, including those at the Financial Accounting Standards Board and the Securities and Exchange Commission. After all, the mark-to-market rules are supposed to provide investors with needed information about the true state of a company's balance sheet.

In the midst of this financial crisis, mark-to-market isn't necessarily telling the truth. The notion of pricing assets on the basis of what they would bring if sold today -- even if an institution doesn't have to sell them -- creates a paper loss that reduces capital and restricts lending.
John M. Berry, Bloomberg