Mark to Market Accounting Explained
What is the mark to market accounting fuss all about? Why has the government got so interested and put pressure on the accounting body, the FASB? Why have some called this so evil and one cause of the current financial crisis?
Big questions- big issue. But first, let's translate this to a personal example to make it easier to understand and capture the emotions.
The idea is to write down the value of assets and liabilities that have dropped. If this were used in your personal finances, you would write down the value of your home by 30% (or whatever) to the latest market value.
However, the latest change put more judgment into it. If you are holding on to the asset for a long time, riding out the fluctuations in the market, you would not have to take a write-down.
Back to your house. If you plan to live in the house for another 10-20 years, you could say that the market will come back and it will regain its value. You could pass on taking the write-down.
But for some people the situation might be different and a drop in the housing market could trigger writing down the value:
- You just have to move and sell the house now at the lower value.
- You are behind in your payments and the bank is going to repossess the house
- You may be in the house for a couple more years but its unlikely it will recover back to the peak value before you will sell
The new ruling will let financial service firms ride out the fluctuations in the market. Their results will not bounce around as drastically versus a pure mark-to-market write-down policy.
The downside is that it opens up room for judgment. Some will take advantage of it and not do the write-downs they should.
Perhaps another approach will be to split income between current and long term results. Maybe we should not box everything into the one year income statement.
The home example is just an analogy. Don't worry- nobody is saying you have to write down your house. Hopefully though it made the mark-to-market controversy a little easier to understand. Perhaps you also felt the emotions that banks and other similar firms feel now when faced with a write-down.
What do you think about mark-to-market? How would you handle it differently?
I think that this policy change has come too late for many of us. I know, as stated, others might hold on too long before they realize that they will not be able to hold their assets for a long time. But, at least, now we have an option we can exercise and it gives consumers some room to make adjustments too. If it was left up to the banks and Mark-to-Market, it would probably be much too late for everyone.
Reply to this