More Mark-to-Market

Starting at around minute 40 of this video, Princeton Economist Alan Blinder has an informative discussion of the mark-to-market issue. Let me try to give a written account that’s less flip than what I wrote this morning. The idea of mark-to-market accounting is that when you’re reporting your balance sheet — your assets and your liabilities — you need to report the value of your alleged assets at what you could actually get for them on the market. In a normal highly liquid market, this is easy and non-problematic. But as Blinder says, in an illiquid and non-functioning market, as we currently have for our “troubled” assets, you get into trouble. Specifically, you get these huge spreads between the bid price and the ask price for the assets and no actual sales happening. Blinder’s example is that if the highest bid is $20 and the lowest bid is $60, where do you value the asset? Thus, “there are legitimate problems that need some attention in how you apply mark-to-market accounting when markets aren’t functioning.”

He continues, however, with “having said that, I know a wrong answer, which is to put it in at face value.” And that’s what proponents (mostly on the right, but also some on the left) of ending mark-to-market want to do. They want to say that you can value your assets not at what you could sell them for, but at what you paid for them. Blinder returns the example of the $20/$60 bid/ask spread and notes that “I’m pretty sure $100 is the wrong answer.” And yet this is the essence of the proposal — take the fact that the assets are hard to value, and use that as an excuse to unambiguously overvalue them. Mark-to-market, Blinder concludes, is “the worst form of accounting until you start thinking about the alternatives.” For obvious reasons, though, this switch has substantial support in some sectors of the finance community and also appeals to some in congress as a “free” way to “solve” the problem.