Mark to Market: An Illusion Parading as a Cure

Market-value accounting, like magic, involves illusions. The fact is this accounting method cannot be relied upon for a true picture of events that have occurred or are expected to occur.

Yet it nevertheless seems to be casting a spell over many who are in positions to make accounting decisions. Why is this an issue, and what is its magic?

The mark-to-market debate encompasses two totally unrelated issues. The first is about marking to market commercial bank investment portfolios.

The second is about marking to market all or most bank assets and liabilities, which is the real, long-term issue for banks.

Differing Opinions

Some believe that marking all or most assets and liabilities to their market values would provide a better measure of value. Some also believe that if the S&L industry had used market-value accounting, the S&L bailout figures would have been lower.

Others disagree, feeling that because market values focus on liquidation values, they are not the appropriate measures for a going concern.

Those who are on the fence about market-value accounting believe that market-value disclosures will provide users of [eligible words] with the additional information necessary to determine the health of an institution.

Others believe that the subjectivity and unreliable nature of the information could result in misleading information.

Who is saying what?

Those in favor include:

* The chairman of the Securities and Exchange Commission, Richard Breeden. He testified that market values should be used for investment portfolios, and he supported the move toward market-value accounting for financial institutions.

* Sen. Donald Riegle, D-Mich., chairman of the Senate Banking Committee. He introduced a bill that includes calls for market-value financial statements. The bill would mandate disclosure of market values of assets and liabilities and the resulting estimated net worth.

* Rep. Henry Gonzalez, D-Tex., chairman of the House Banking Committee. He introduced a bill that includes a requirement for reporting all assets and liabilities of insured depository institutions at fair market value, unless regulators should determine that it is inappropriate in a particular case.

* The Federal Home Loan Mortgage Corp. Testimony from the agency held that the Office of Thrift Supervision should "keep track of thrifts' market values" as an improvement over its interest-rate risk component of thrift capital requirements.

Those opposed include:

* The Department of the Treasury. The department says that it is premature to impose market-value accounting. However, market-value disclosure is an alternative to market-value accounting.

* Federal Reserve Chairman Alan Greenspan. He wrote that the adoption of market value for investment securities "could result in volatility in reported earnings and capital that is not indicative of the bank's true financial condition."

* Comptroller of the Currency Robert Clarke. He identified a number of problems with market-value accounting and said it needs to be thoroughly studied. He argues that it "would drive business decisions" and that it "does not represent merely a change in bank accounting -- it represents a change in banking policy."

* Richard Darman, the director of the Office of Management and Budget. He said that this is not the time for market-value accounting. "It has to be approached on a more gradual, more orderly, more carefully thought through, better coordinated basis than is reflected in the proposal to simply do it...." * Banks. The American Bankers Association strongly opposes market-value accounting.

And those who haven't officially decided include:

* The Financial Accounting Standards Board. The board proposed that market-value disclosures be required for financial instruments unless it is not practicable to estimate market values.

In such circumstances, other disclosures would be required.

Why do bankers object to market-value accounting?

* The market-value accounting model is based primarily on constantly changing interest rates, together with subjective secondary market information, and is complicated by the need for excessive use of estimates. This will cause market-value financial statements to be very subjective, volatile, and unreliable.

* The existing historical cost accounting model is practical and understandable.

* Market-value accounting would have no positive impact on the deposit insurance system and could very possibly have a negative impact. This is because the subjectivity, volatility, and unreliable nature of market value financial statements could severely impede regulatory monitoring of capital adequacy.

Also, the uncertainty of the earnings results would constrain the ability of banks to raise capital, weakening the banking system and thereby creating more risk to the insurance funds.

* Users of financial statements are many and varied. Market-value financial statements are designed to meet the needs of a very limited group of users - those interested in an estimate of liquidation value.

* Banks would incur significantly higher costs for an end product that, at best, has little value and, at worst, could be misleading. Users will rely on the new basis for measurement when, in fact, that measurement is not appropriate for a going concern. The tremendous difficulty in implementing a reporting system that would not mislead financial statement users should not be underestimated.

* Over the last five decades, there have been numerous discussions about various aspects of market-value accounting. The consistent recommendation of these discussions and studies has been the retention of the present reporting basis.

The Appeal of this Accounting

What is the magic?

Market-value accounting does not represent an improvement over the accuracy of evaluating credit risks, which are typically the highest risks to financial institutions. Those credit risks do not go away with market-value accounting, nor does the need to evaluate those risks.

If the whole point of the exercise is credit losses -- which must be calculated either under existing accounting or market-value accounting -- then haven't we gone full circle? Admittedly, the historical cost model may not be perfect, but jumping ship from historical cost to market-value accounting is likely to create more problems than it would solve.

Ms. Donna Fisher is the accounting policy representative for the American Bankers Association, Washington.

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