Meltdown 101: What is mark to market accounting?

[November 22, 2008]  NEW YORK (AP) -- In all the finger-pointing about the credit crisis, there's one unusual suspect: an accounting standard.

Critics say the standard called "mark to market," or "fair value," is one cause of the nation's financial woes. Others contend that has nothing to do with banks' troubles.

Here are some questions and answers about mark to market accounting.

Q: What is mark to market accounting?

A: Under the standard, companies must value securities they hold, such as mortgage-backed notes, at their current selling price.

As investors sold off securities in droves, their prices have fallen. As a result, banks have had to reduce, or write down, the value of assets they hold, making their balance sheets weaker.

Regulations say that banks must hold minimum amounts of capital -- cash, government securities and loans -- and writedowns shrink that capital. That has forced banks to scramble for cash, selling assets or seeking buyers for whole businesses so they can meet their minimum requirements.

Q: Is mark to market accounting being reconsidered?

A: The legislation that created the $700 billion bailout also requires the Securities and Exchange Commission to study mark to market. The latest of two SEC roundtables on the topic was held Friday.

Q: What happens when a market for a security, like mortgage-backed securities, simply evaporates?

A: There are provisions for finding a security's fair value when the market freezes.

"Writedowns are not -- and have not been -- required based on prices in illiquid markets characterized by distressed sales (e.g., those associated with sales necessitated by the need to meet regulatory capital requirements)," said Wayne Landsman, an accounting professor at the University of North Carolina business school, in remarks submitted to the SEC.

Translation: If a bank desperate for cash sells assets at fire sale prices -- but the price of those assets are holding up elsewhere -- other banks don't have to mark down their assets to the cheapest possible price.

Q: What's the argument for reconsidering mark to market accounting?

A: The American Bankers Association and others argue that mark to market has not worked properly because the standard does not provide enough guidance on how securities should be valued in turbulent markets.

"As financial markets thin out or even seize up, as trades become fewer and more volatile, and in general as trading values become increasingly unreliable, it is daily more apparent that for many assets, especially under current conditions, there is not a true 'fair value,'" Donna Fisher, a tax and accounting executive at the bankers association, wrote to the SEC.

Q: Why keep mark to market accounting?

A: People who argue for keeping mark to market accounting say the alternative is "mark to myth." Their argument is that mark to market reflects reality -- if you've made a rotten investment and no one wants to buy it, its fair value will rightly be low.

"Fair value accounting is only a means of communicating information that is important to investors and other market stakeholders, it is not the underlying cause of the current economic crisis," the Center for Audit Quality and the CFA Institute said in an October statement. "Suspending fair value accounting during these challenging economic times would deprive investors of critical financial information when it's needed most."

Other groups supporting the standard are the Council of Institutional Investors and the Consumer Federation of America.

"We do not believe that fair value accounting was the cause or even a contributing factor to the current credit crisis," the chief accounting officer and director of accounting policy at Credit Suisse wrote in testimony to the SEC.

Assistant Treasury Secretary Neel Kashkari, who oversees the government's $700 billion bailout program, said in an early November speech, "People are pointing the finger at mark to market accounting, but I haven't heard anyone come up with a better alternative."

[Associated Press; By ELLEN SIMON]

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