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Mark to Market Accounting: Is it time to bend the rules?

Nov.13.2008

  • Mark to Market is an accounting rule which values investments such as securities, portfolios or accounts based on the daily value of such asset, i.e. the price they would achieve if they were sold on the market at that time, and not at the date of maturation of that asset.
  • Mark to Market accounting, or fair value accounting as it is sometimes referred to, arose partly in response to the US savings and loan crisis in the late 1980s and early 1990s, where financial institutions carried inflated asset values on their books. Following on from this, there was a shift from valuing balance sheet assets at their purchase price to fair market value.
  • During the mid 1990s some companies incorporated Mark to Market accounting using it on an unprecedented level for trading transactions. Trading transactions are often more suitable to Mark to Market valuations.
  • Mark to Market accounting rules have recently been blamed for weakening the balance sheets of banks and insurers as asset values fell during the credit crisis, forcing institutions to report current depressed prices. Where illiquidity strikes the market, a true Mark to Market valuation is not attainable, as there is no "market price". This change in turn led to a problem in meeting banks' capital adequacy requirements therefore throwing the future of financial firms into doubt and eroding investor confidence.
  • The International Accounting Standards Board ("IASB") have agreed that these rules should be relaxed following intense pressure by some European banks and politicians. The IASB is now allowing banks to reclassify assets such as loans and receivables by granting them the discretion to use alternative valuation methods that would clarify them as long term investments so as to better capture the fundamental true long term economic value of an asset.
  • European companies believe that their US rivals have options that they do not have giving them a competitive edge. Relaxation of the rules will assist in bringing European accounting standards into line with their US counterparts. In the US, reclassification of assets to and from trading books is permitted in rare circumstances such as in times of financial crisis.
  • Some analysts have argued that allowing banks to reclassify certain assets reduces consistency and transparency of financial statements between banks thereby further lowering confidence in potential counterparts.

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