Mark to Market as explained by a dummy.
I’ve been having a good conversation via the comments section with a couple of financial experts about the merits of the SEC’s proposal to let banks escape the accounting requirement that they “mark to market” their portfolios of toxic loans. Marking to market means adjusting a firm’s books to reflect the actual market value of an asset. If the market price goes up, the asset’s value is adjusted accordingly. If it drops, however, well it’s quite the other way around.
Right now, banks don’t like the rule because the market value of those toxic loans is zilch – no one wants them. “But there really is value there,” the banks complain. “If we carry them at zero our capital requirements will rise and since we don’t have any more money, we’ll be forced into bankruptcy!” The government has listened and now wants to permit the banks to assign a value to these assets at some level, as-yet-undefined, above zero. I, in my ignorance, opined that this made sense because, down the road, there would be value realized in these loans and why put still more banks out of business while we all awaited a recovery? I was quickly set straight by a couple of readers. Once you abandon the mark to market rule, they warned, you abandon the last vestige of accounting discipline and open the floodgates to “creative accounting”. This is what brought us the Savings and Loan disaster and it will happen again, if we permit it. (The only remaining section of the New York Times that I will read is its Business section and here’s a good article on this topic by Floyd Norris, “Mistakes of the Past Live Again” ). By the way, Warren Buffett thinks the idea stinks, too – hearing him say so during his interview with Charlie Rose the other night sealed the deal for me.
Why is all this in a quasi-real estate column, aside from Wall Street’s collapse affecting our property values? Because, in my opinion, many home sellers are acting like those banks. They “know” that their house is worth more than its current market value and they refuse to mark its price down. Home values will rise again, they reason, so why admit that, today, their house is worth 20% less than it was last year? That’s fine, if you don’t need or want to sell your house right now. No accounting rule will force you to make the adjustment (unless you go to refinance your house) and you can just sit and hope, fingers crossed, until prices start climbing again – maybe in 2014, maybe sooner, maybe later than that; your guess is no worse than mine. And there’s a comfortable feeling believing that your house is still worth what it once was – I do it myself; I see no need to acknowledge that my own $2 million dumpster duck isn’t worth that anymore and I like the reassuring feeling of wealth it givs me.
But I’m not trying to sell my house right now so I don’t have to admit reality. Neither do you, unless you are ready to sell. If you are then, SEC laxness or not, you’ll have to get real.