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Mark-to-Market Explained

Volokh.com 30 September 2008 One Comment

As a business appraiser in a CPA firm, I see similar issues all the time. The problem is that we have conflicting definitions of the word value. The new rules essentially define value as “what you can cash out for today.” In some circumstances, this may be the important number to know, but in others, it’s more important to know the intrinsic value–the present value of what you can expect to receive from it, allowing a proper rate of return for the risk involved.

The problem occurs when readers of a balance sheet, who are used to seeing numbers closer to intrinsic value, suddenly see lower market-snapshot numbers and think it’s an intrinsic number. This may have a substantive effect in the case of banks, where the reduction can throw you out of regulatory compliance, or where a loan covenant is endangered. (Kind of like playing a basketball game and having the 3-point shot retroactively repealed.)

9.23.2008 8:48pm


Michael F. Martin (mail) (www):

This is actually very simple economics. Mark to Market is a disaster from the point of view of an investor interested in assessing the book value of a company.

If assets are carried at cost, the INVESTOR can consult the market to see what the assets would be worth in liquidation, and thus the INVESTOR can determine whether she has a margin of safety in purchasing a company based on its book value.

When the company is permitted to mark its assets up (or down), investors lose a key reference point — cost — which is necessary to determining the underlying value of the company.

It’s really not more complicated than that. Enron, Worldcom, Bear Sterns, now Lehman. How many more examples do we need to prove that mark to market is an inherently unstable mechanism for accounting for asset value?

9.27.2008 12:57pm


Michael F. Martin (mail) (www):

I’ll just add that in general the problem with the “free market” right now is that professional accountants have too much control over the accounting standards. Their reaction to each crisis has been to further limit the amount of information available to investors and the public whereas more information and less editing and summarizing are what is necessary for a free-market to stabilize.

One Comment »

  • Chris Gould (author) said:

    I agree that Mar to Market has to go. Sarbanes Oxley is here with a purpose of clarity, but those fighting against it – including the free agent accountants that are earning huge hours working it – need to recognize the difference in public company versus private. How many large private institutions are at the public trough this week begging thru the Fed Window?

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