The mark to market accounting system,as an accounting device became popular in the 1980's. The system was supposedly a foolproof method for valuing various financial instruments.Large corporations and banks adopted these rules as they felt that they provided a more transparent method of determining profits.
Now these very rules are being blamed for precipitating much of the subprime mortgage crisis.It is argued that they have compelled financial institutions and banks to exaggerate their losses on hundreds of billions dollars worth of assets.These massive write downs have been blamed for forcing several giant companies to seek federal aid in order to avoid bankruptcy.It is argued that this wholesale reduction of lending capacity is the primary reason behind the current economic slowdown.
It is tempting to accept the above argument. Unfortunately it does not give the true picture. M to M rules are perhaps the most accurate method of valuation if the assets are liquid and are traded regularly. However if the assets are not very liquid,as most of the mortgage backed securities are,then distress sales are likely to cause wild fluctuations in their prices. The present problem arose when companies needed to put up extra cash and had to liquidate such securities in a hurry.In a market where liquidity had suddenly dried up price fell very sharply.Compounding the problem was the fact that many of these securities were novel instruments which did not enjoy a ready market even in normal times.Many banks that held them perhaps had no intention of selling them.
The FASB has approved changes that will allow auditors to use 'significant professional judgment' to value such illiquid securities.Although the change may prevent further write downs it remains to be seen whether it will allow the reverse or 'write ups' to happen. Till houses and cars start selling again and the overall economic scenario takes a turn for the better, it is unlikely that any accounting jugglery is going to help matters.