What Is Mark To Market?

Hear Dave explain what mark to market is, and how it relates to common sense.

QUESTION: John asks Dave to explain mark to market accounting as used in common sense.

ANSWER: When Enron, WorldCom and Adelphia went bankrupt because of fraud, they put assets on their books to make the company look they were worth a lot of money. If they bought something for $10 billion and later it was worth $4 billion and they never marked it down on their books, their books looked artificially bloated and the company looked richer than it was. That’s what they did wrong and that’s why they went down.

A law was passed after that called Sarbanes Oxley, and it went too far the other way. It states that if you have $10 billion on the books and it goes down to $4 billion, you have to mark it down or up to its market value. It’s a good thing until you have these subprime loans, which can’t be sold because there is no market for them. By market them down to almost zero when they may be worth $20 billion or so, it artificially makes the banks look weak and causes some of them to close.

I don’t want to teach people to cook their books or lie to their stockholders, but this is an unintended consequence of regulations. In a market as wild and crazy and complicated as our markets are, you can’t anticipate this.

A recent guest of mine, an economist named Brian Wesbury, and he made this example. If your house is worth $300,000 and your neighbor gets foreclosed on and they sell his house for $150,000, because of that, the bank might say your house is only worth $150,000, and they would say you need to write them a check today. If you say you weren’t going to sell, they say it doesn’t matter and you need to write a check. If you say that will force you into bankruptcy, then they say they will bankrupt you. That’s what has happened to these banks. They are sitting on something that will recover and work its value out, but this weird accounting rule is forcing these problems. Removing the accounting rule doesn’t cause any problems to anyone at all anywhere, if you do it just for the subprime loans for 2 years.