Dropping Mark-to-Market is a Bad Idea

When I first started hearing buzz about dropping “mark to market” accounting rules it sounded like a very bad idea to me. That said, it’s obviously not an issue I’m deeply versed in, and I heard some disagreement among folks who seem credible. But just as the Federal Accounting Standards Board was gearing up to relax mark-to-market rules, CAP’s Associate Director for Financial Markets Policy, David Min, was putting together this detailed explanation of what mark-to-market is and why we ought to keep it.

First he lays out why it’s the right standard, and then he argues (persuasively I think) that this FASB action is likely to compound our “animal spirits” problem and continue keeping investors in a maximally risk-averse posture:

So what would happen if FASB or regulators decided to repeal or suspend fair-value accounting rules? Well, any such moves could have severely deleterious effects. First, they would likely undermine investor confidence, decreasing transparency and increasing concerns about the accuracy of bank financial statements. This could have the effect of prolonging or worsening the credit crisis.

Second, the temporary or permanent cessation of fair-value accounting would set an unbelievably bad precedent—one that could wreak major damage to the integrity of U.S. securities markets. The setting of U.S. accounting standards has long been an independent nonpartisan process, free from political pressure. This is no small part of the success of the U.S. capital markets as it has created strong investor confidence that the rules of the game—the standards by which U.S. reporting companies disclose their financial results—are fair and will not change suddenly and arbitrarily.

Both of those sound right to me. On the second point, especially, it’s worth noting that it’s not as if what FASB did here was bow to longstanding critics of mark-to-market. The loudest voices calling for its dilution were the people who benefitted from marking to market when things were on the upswing, and then were hurt by it during the downturn. People behaving opportunistically is nothing new, but it’s bad for regulators to be willing to play calvinball like this and just switch accounting standards around to whatever happens to be more beneficial to certain firms.

It’s worth noting that part of the background to this crisis is a series of breakdowns by key supervisory institutions. This goes back to the dot-com bubble and bust. That stock market crash revealed substantial corruption in the practices of the major accounting firms in a way that was never really resolved. And the regulatory gaps were plugged by the Sarbanes-Oxley bill that’s almost universally seen as a failure—simultaneously burdensome to comply with and substantively toothless. Then more recently we’ve seen that the bond rating agencies can’t be trusted, and yet they’re still all there and still playing a crucial quasi-official role in the economy. Additional funny business with accounting and regulatory oversight is only going to further inspire people to fear that lurking behind any potential investment opportunity is some kind of scam that you’d do well to steer clear of.