Mark to Market Accounting

D

Damian85

Registered User
Messages
92
US accounting bodies have eased up on mark to market rules.

Do people agree with existing mark to market standards, and what are the main advantages and disadvantages?
 
Advantages - this can stop the downward spiral of falling asset prices (forcing illiquid assets to be valued at the latest fire sale value) and the need to raise capital becomimg self re-inforcing
This gives the system time to earn its way out of the current predicament

Disadvantage - less transparency for all investors.

Personnally I think its a sensible move, one that can be reviewed again a ta later time
 
Yeah I would agree, it is sensible and necessary. If a market is inactive, asset prices can be drastically undervalued. FASB by providing a temporary relaxation of these rules prevents the accounting for losses now, during a contracting economy. If the assets are still as impaired in, say five years time, the book values will reflect this when they are sold. This hopefully will act as a shock absorber and perhaps pervent endless stimulus money being poured into banks and companies most effected by this.

However, there is potential that the objectivity of using discounted cash flows may be questionable. Some companies may decide the value they want and then just manipulate some of the underlying assumptions or discount rates to arrived at the desired value.
 
I view the relaxation in the same light as I viewed the short-selling ban. It is misguided and ineffectual at best if not damaging. Unforeseen consequences are ignored. For example, the ban on short selling made hedging debt more difficult increasing the yields on bank debt which increased pressure on the banks' cashflow which depressed the share price; the opposite of what was intended.

This measure will simply make investors even more distrustful of balance sheets and increase the uncertainty surrounding the companies' book value which if anything will depress their share prices.

The markets know better than to trust figures published in quarterly balance sheet summaries anyway; the share prices of the Irish banks over the last year show this as even when the banks were paying big dividends and filing marvelous looking returns, the markets had discerned their true state and were discounting their balance sheet equity.

I really don't see how allowing banks to invent figures for the value of some of their assets will help the economy or the stock market. If this measure is expected to increase "confidence", then it will do the opposite. This measure can only be viewed as sensible if you believe that if something was once worth X, then it will be worth X in real terms again if you are prepared to wait - a notion which is completely false based on the history of asset price movement.
 
The intentions of FASB were sound and in the long term in the best interests of investors. The unintended consequence was that it both amplified and reinforced the asset write down cycle which became self re-inforcing. A temporary relaxation is a rationale and sensible approach, to allow more detailed analysis of how to get the intended benefits without the negative side effects. A similar approach to the Savings and Loans crisis in the U.S meant that over time the banks could earn their way back to solvency with less requirement for public money.
 
The whole concept of the mark to market revolves around market valuation. If the market is dysfuntional, like many perceive it is, then this sensible. If fear, liquidity problems or forced liquidation enter a market, then impairment losses enter a perpetual cycle.

I'm undecided about this relaxation and I am undecided about the merits of mark to market. I see great disadvantages and advantages in both.
 
There is not enough empirical evidence to be sure who is right about this issue, but leading economists have been covering this subject recently. In summary:

Those against marking to market argue that the transaction prices for securities sold under duress do not reflect their true value. If two people both own relatively illiquid assets and one chooses to sell quickly at a fire sale price, mark to market accounting may force the other to write down the value of their assets to the transaction price.

Unless the second person also plans to sell their position quickly, this undervalues their position. The critical question, however, is whether the first transaction price is more accurate than the model value the second person would use if they are not forced to mark to market.

An equilibrium view of prices would dictate that the observed transaction price is typically more accurate than the model. In other words, marking to market would improve the accuracy of balance sheets in general.
 
The reason why asset prices have to come down is because the prices of those assets are too high.

What we have here is a scam. Albeit a legalised one but nonetheless a scam.

I wouldn't trust a thing that comes out of a bank these days. I'm going to take every penny I have out of my existing account.

Do they take us all for fools?
 
UptheDeise said:
The reason why asset prices have to come down is because the prices of those assets are too high.

What we have here is a scam. Albeit a legalised one but nonetheless a scam.

I wouldn't trust a thing that comes out of a bank these days. I'm going to take every penny I have out of my existing account.

Do they take us all for fools?
Click to expand...

I wouldn't agree with that. The downside to mark to market accounting, as Marc pointed out, is that it can force the holder of the asset to write down the asset to the 'perceived market value'.

Valuation is subjective at the best of times. If a period of forced liquidation enters a market, as we have seen in recent months, assets are sold in desperation. Holders of similiar assets may then have to make write downs to reflect this, regardless of whether they ever intend to sell the asset.

Take a simple example:

If the market place consists of 2 companies. Company A is in a strong position, but Company B is highly leveraged and needs cash. Both hold an asset worth 3 million. Presume that the value in use of this asset is also 3 million. Company B needs cash quickly and buyers realise they are in a bad situation so it sells the asset for 2 million. Mark to market accounting may dictate the market value to be 2 million. Company A could suffer a 1 million write down, despite never having an intention to sell this asset. This 1 million may then have to be put through the Income Statement, which effects the profit of Company A for that period.

The 'one size fits all' approach based on what the market perceives is the problem here. Mark to market presumes an efficient and liquid market. Market imperfections are inevitable. Flaws of mark to market occur when fear grips a market, margins are called, liqidation is forced and sellers have poor bargaining power.
 
UptheDeise expresses more starkly what I feel about allowing banks and other institutions to value assets and liabilities internally when maintaining their balance sheets.

The idea there is benefit in valuing something far more than anyone is willing to pay for it (or far less than anyone is prepared to sell it to you) is dubious enough to require a very high bar in terms of evidence or argument. Describing the only market for what you're selling (or buying) as being "dysfunctional" (a meaningless term which lacks an accepted definition) seems evasive - effectively blaming the rest of the world for not providing buyers or sellers at the price you feel you deserve. If you buy highly illiquid assets or highly volatile assets then its nonsense to blame "markets" for not providing you with buyers/sellers or for going up and down.

When investors look at the book value of a company, I imagine that they'd like to have a modicum of confidence that the balance sheet summary reasonably accurately represents what the company is worth. I see no benefit to forcing investors to perform forensics on a company's accounts in order to discern its true state; two companies could both claim to have half a billion worth of shareholder equity but but I'd rather NOT have shares in the one where 400 million of that equity is represented by a peak-of-the-boom price for "development land" in Roscommon which could be worth anything but certainly is worth less than the book value.

I'm also skeptical that the S&L crisis provides any evidence in favour of relaxing mark-to-market accounting rules; from what I recall the S&Ls didn't just "trade" their way out of difficulty - many went bust and nearly all required a share of the nearly 150 billion dollars that the US government spent bailing them out (this was back in the 80s/90s when money was money as they say). Not mentioning this 150 billion while arguing that relaxing mark-to-market accounting helped save the S&L industry in the US is disingenious.
 
I wouldn't agree with that. The downside to mark to market accounting, as Marc pointed out, is that it can force the holder of the asset to write down the asset to the 'perceived market value'.
Click to expand...

Ah that's not a downside of mark to market value. it gives the best value of a asset at a given point in time. Houses prices have decreased over the last year because the market is bottoming out.

Valuation is subjective at the best of times. If a period of forced liquidation enters a market, as we have seen in recent months, assets are sold in desperation. Holders of similiar assets may then have to make write downs to reflect this, regardless of whether they ever intend to sell the asset.
Click to expand...

No, valuation is not subjective, in fact if we allow the market to work in an open and free manner, valuation is objective.

Take a simple example:

If the market place consists of 2 companies. Company A is in a strong position, but Company B is highly leveraged and needs cash. Both hold an asset worth 3 million. Presume that the value in use of this asset is also 3 million. Company B needs cash quickly and buyers realise they are in a bad situation so it sells the asset for 2 million. Mark to market accounting may dictate the market value to be 2 million. Company A could suffer a 1 million write down, despite never having an intention to sell this asset. This 1 million may then have to be put through the Income Statement, which effects the profit of Company A for that period.

The 'one size fits all' approach based on what the market perceives is the problem here. Mark to market presumes an efficient and liquid market. Market imperfections are inevitable. Flaws of mark to market occur when fear grips a market, margins are called, liqidation is forced and sellers have poor bargaining power.
Click to expand...

Your example is illogical to say the least and flaudulent at best.

Say you want to buy a house that was once worth €500,000 but is now worth €300,000. Are you going to pay the 5 because the owner has suspended mark to market valuation or are you going to offer the 3 because the market has dictated that to be the real price of that house?
 
Damian85 said:
Valuation is subjective at the best of times. If a period of forced liquidation enters a market, as we have seen in recent months, assets are sold in desperation. Holders of similiar assets may then have to make write downs to reflect this, regardless of whether they ever intend to sell the asset.
Click to expand...
Sorry I missed your post when posting. If a company invests in an illiquid asset, then I do not see why they should be provided with an accountancy trick in order to hide the fact that the asset is difficult or impossible to sell. I hate the term "race to the bottom" but that's effectively what is being proposed here; companies with lots of volatile or illiquid and currently worthless "assets" on their books want to be able to present a balance sheet which makes them look like a company holding solid liquid assets.

Where were all the mark-to-market critics when all classes of assets were booming in value? I don't remember them making a hullaballoo that the bull market was "misspricing" assets and as a result should be considered "dysfunction". Now that the bull has turned bear, it seems that using the market to price assets was "unfair" or misleading all along.

It's hard not to believe that the this political pressure is motivated by the fact that many bonuses are tied to yearly profitability. Getting rid of mark-to-market arguably benefits the company management; I can't see any benefit for investors. Perversely relaxing mark-to-market will incentivise comapanys to hold riskier and less liquid assets which has been a major contributing factor to the current economic mess. For example, if a company blows up in year 10 due to exposure to dodgy OTC derivatives or property investments, it's an unmitigated disaster for investors but the execs and management still get to pocket 9 years of bonuses.
 
Now we're getting into a bit of a debate!!!

My opinion is split on mark to market accounting. I do tend to favour FASB's decision to relax the rules as sensible. This is a temporary measure, and if assets are sold in the meantime they will be written down accordingly. It benefits holders of assets who never intend to sell these assets and get the full value from these assets through usage, income generation etc.

When and if this financial crisis come to an end, mark to market needs to be reviewed by all accounting bodies. The double edge sword element to it is problematic. Income smoothing (another debate) or income consistency is important for a market. In good times, the volatile upswing of a strengthened balance sheet are offset by the down swings of impairment losses.

I will not believe for a second that the market has been rationale in recent times. Sellers of these assets are not in a strong position for the reasons I mentioned. A company which never intends to sell an asset is being forced to realise impairment losses and mark the asset to some theoretical, perceived market price from a buyer who is unknown to them. I am not talking about housing prices at all. I am talking about financial assets which are still performing steadily or even company assets which a company will get its' full value in use from. Realistically, if you are forced to sell an asset with a weeks notice, you will do an awful lot worse than someone with six months notice. Cashflow problems have lead to a lot of fireselling of perfectly functional assets.

I also feel valuation is subjective. Value is based on perception and calculations which can be fundamentally flawed. If objectivity was how assets were valued, we would never have had all these bursting bubbles and a 'greater fool' mentality. Valuation is set by a subjective market place which goes far beyond simple demand and supply.

Keep it rolling.....
 
Last edited:
You must log in or register to reply here.
Back
Top