A Novel Criticism of “Mark-to-Market” Accounting Rules

One of the many ways hat Obama is artificially inflating the value of bank stocks is by allowing “mark to market” accounting rules.

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Bankers often complain about mark-to-market accounting rules these days. To see what they wish for, and how they would have to value their assets in order to operate like other actors in the global marketplace, consider the following thought-experiment.

Say you have $6. You spend $5 of that monie on a can of coca-cola, because you are foolish and easily tricked. You now want to go into the insurance business, but because this means that the quality of life of many people you do not even know would be in your hands, the government has regulations to make sure no fly-by-night insurance companies run by foolish and easily tricked CEO get off the ground.

“You can be in the insurance business,” the government official says, “as long as you prove to me you have at least $3. This way, we know you aren’t a complete fraud or loon.

“No problem!” you say. “I have $6! $1 in cash, and $5 worth of one can of coca-cola!”

At this point, the government regulator gets a headache from your attempt to make him as recklessly optimistic about pop can futures as you were, and points you to a sign. “Mark-to-market accounting rules only.” “I’m sorry,” says the regulator,” but unless you can prove that someone, somewhere, is selling the can of pop for $5, you can’t say it’s worth $5 to me. That means, you can’t go into the insurance business!”

This is what bankers are complaining about. Why aren’t the assets they bought for a price accounted for according to that price? Why can’t their wishes become your reality?

But, in this thought experiment, you go outside, and check all the stores, gas stations, and pop machines for their prices. Walmart is selling pop for a quarter. The machine at Target is going for 50 cents, and the machine at your kid’s school is at 60 cents. In the mall a can costs $1, and at the airport across town is a machine selling a can of coca-cola for $2.

Eureka! You found it! You can go into the insurance business! And if a plane crashes, a trail derails, or a comet strikes, you’re covered! You can just sell your cans of cola for $2!

Now for several years these are going well. Of course, you complain that the government is only allowing you to “mark-to-market.” Go to the movie theatre (it’s closer than the walmart, and you need them now!), buy a can that cost about 12 cents to distribute, and is for sell elsewhere for 50 cents, for $5 (as I said, your foolish and easily tricked). Account for it as $2 (because that’s what their charging for it at the airport), and sell insurance policies. You’ll need to borrow money for this, but you secrelt know (somehow) that the real value of the pop can is at least $5. For every $2 in policies you sell, you “cover” it with $2 worth of a pop can you paid $5 for, but expect to get rich from in the future! What a profit! life is good!

But then tragedy strikes. A plane crashes, a trail derails, and a comet strikes. Many houses burn down. People look to you for money. You don’t have it. Cash if fact, capital is theory, and you are sort of funds and way long on pop cans.

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So what do you do? Declare pop cans to be “toxic assets,” go on the Treasury Department, and demand a bail-out. Blame mark-to-market accounting while you’re at it, because the market price for pop cans (a measily $2, according to your accounting) is artifiicial low! You paid $5 for them!

Fortunately, in this thought experiment you have made the right friends, and your pals in the White House and Congress give you billions to cover the cost of insurance policies you sold, but could never cover in the first place. At first the government says you need to pay them back (the government takes preferred shares in exchange for the money), and then when you complain loudly enough, the government clarifies that you only will need to pay some fraction of the profit you make when pop cans magically cost more than $5 (by converting the preferred shares into common shares).

So what do you do? Go on CNBC, and complain about mark-to-market accounting rules! They are making you account for your wealth at only $2 a can, instead of $5, even when there are “no buyers.” (By this, you mean that only people nearly as optimistic and risk-taking as you will pay $2).

This is how mark-to-market accounting rules work. Mark to market accounting rules work as a bailout to banks, buy allowing them to list assets at prices too high to sustain regular market operations. The price of the marked-to-market assets only appears to be as high as it is because the banks aren’t selling the assets they do have. The price required to find many buyers is much lower than the price to find just a few buyers. In the same way, you can probably find someone willing to pay $2 for a can of coca-cola. If you want to sell a million cans, however, you’re looking at something closer to 50 cents.