My Response To The Question "Why Does Mark-To-Market Matter?"

Some are wondering why mark-to-market accounting matters. They state that it is understood it might help improve some balance sheets, but it is not going to make anything more liquid. They imply it will simply result in banks coming up with new ways to value a bunch of junk they cannot sell.

I think this is one complaint by the 'long-and-wrong' crowd that's bona fide.

You have a few, small indices out there such as the ABX or CMBX for asset-backed and commercial mortgage-backed securities that can be pushed around in opaque trading. If those indices reflect lower valuations or a higher probability of default, the banks have to mark their thinly traded or non-traded holdings down to the market in accordance. That leads to a charge against the balance sheet and lowered capacity to lend.

The issue then becomes the ability of the financial system to support the real economy, not to improve the liquidity of various derivative instruments.

I agree that elimination of mark-to-market accounting and replacement with mark-to-model or "mark-to-myth" would lead to abuses by the banks. No one will ever push the pencil against themselves, or as we have seen with the British Bankers Association and LIBOR, against other members of the club. If we bring in outside pricing services to mark the assets, we have a problem the likes of which we have seen with the credit rating agencies.

At the end of the day, the assets must be valued somehow. Marking-to-market against an easily manipulated index is imperfect, as is marking to a self-serving model. The former hurts the holders of the assets; the latter will hurt almost everyone else after the inevitable abuses. Hopefully a constructive alternative can be formulated.