Michael Page on Why Marking to Market Needs to be Reformed

Yes folks, it's time for the weekly anti-fair-value-accounting post. Thanks to Alea for pointing out this letter to the Financial Times editor, where Michael Page suggests why mark to market was flawed:

Calls for the suspension of marking to market and fair value rules should be supported, not because the rules were the cause of the crash, but because they were the cause of the bubble that preceded it. In bending the knee before the illusory power of the market, accounting standard setters have ignored the unintended consequences. Marking to market was an invitation for operators in financial markets to make up numbers and pay themselves accordingly. Enron was a warning of what could happen. We know market prices are highly variable and accounting standard setters should now acknowledge that the role of accounting is not to mimic market prices but to provide a more reliable alternative.

Apologists for marking to market say there is no alternative, since it is impossible to calculate the intrinsic value of some instruments. If this is the case, what were institutions doing buying instruments for which they had no idea of the intrinsic value?

[...snip...]

Michael Page,
Professor of Accounting,
University of Portsmouth,
Portsmouth, Hampshire, UK

I'm not sure what a reasonable solution would be right now. The accounting bodies didn't do anything after Enron exploited it--possibly because the accountants were culpable in that collapse (mostly due to unrelated fraud) and wanted to bury that mess--but it's about time they looked into this issue. It certainly needs to be reformed for the long-run, but how to implement something without mucking things up right now?

I have been bashing fair-value accounting for more than an year now but even I feel that it should not be suspended. Businesses that buy assets to sell (such as investment banks) should be marking to market on a regular basis. But insurance companies, banks, government agencies, non-financial corporations, and others, who buy assets to hold for the long term should be given some leeway. The latter parties should not be marking to market and instead charge impairments when real impairments have occurred. But there is a thin line between an investment to hold and an investment to sell and regulations need to be tight enough.