The FASB this week backed off on a plan to expand mark-to-market accounting to loans and deposits. To understand what the FASB actually did, you have to understand a bit about how financial institutions currently account for assets.
Currently, most loans are classified as “hold to maturity”. Such assets are carried at values based on historic cost, unless they experience an “other than temporary impairment” in value. In that case, the loan is supposed to be irreversibly marked down in value. (When a developer files for bankruptcy, his mortgage has probably suffered an other than temporary impairment.)
Accounting rules also identify “trading assets” and “available for sale” assets. These are currently marked to market, meaning that their value on the balance sheet varies with their value. (There is a separate question of how marking to market affects reported earnings. We can ignore that point for this discussion.)
If the rules seem Byzantine, well, they are. It’s true that it’s not always easy to value assets, and advocates of historic cost accounting will point to the potential for fraud and deception when assets are marked to market. It’s true that prices in a thin market may not be representative. Also, the FASB wanted to harmonize US and international accounting rules, an important goal. But why should the accounting system rely on the bank’s declaration of intent about its holding period to determine how the asset is to be valued? If it is hard to value, why not report it as such? If it is possible to mark it to market, why not do so?
In most cases the bankers have a reasonable idea of what their assets are worth. The regulators also know the truth. The hedge funds probably know the truth. But the FASB says that firms are not required to tell you what they know. You, as a member of the investing public, are being told that you can’t handle the truth. There are consequences when the accounting system does not respect economic reality: witness the crisis in state pension systems.
Historic cost accounting is like a stopped clock, which provides the correct value twice a day. With a stopped clock, you always know the reported time, and you know where the number came from. Mark-to-market accounting, on the other hand, is unquestionably messier, like a real clock. Is the clock running fast or is it slow? Was it adjusted for daylight savings time? Can it be manipulated? (Of course.) But which kind of clock helps you make better decisions?