Strong Arguments Can Be Made Against Mark-to-Market Accounting

One can make the case pretty easily that mark-to-market accounting has played a huge role in the deterioration of the nation’s leading banking franchises. Essentially, many banks across the country are being forced to write down the value of investment securities even if little or no loss has been, or is expected to be, incurred. Such writedowns are forcing banks to raise capital to cover losses that in many cases are never going to occur. Does that make any sense, or should banks report losses when they actually lose money? That is the key question surrounding the mark-to-market debate.

Consider the following example. Bank of New York Mellon (BK) presented at the Citi Financial Services Conference on January 28th and included the following slide in their presentation:

As you can see, the company wrote down its securities portfolio by more than $1.2 billion in the fourth quarter but based on the principal and interest payments these securities are producing, they only expect to lose about $200 million. Mark-to-market accounting rules are forcing them to take more than $1 billion in writedowns in excess of what they they believe will really be lost. Practices like this are undoubtedly putting more stress on the banking system than is necessary.

I have no problem requiring firms to write down assets before a loss is actually taken if they believe they will actually have a loss in the future. But to require them to take losses based on wildly volatile market prices (which are often inefficient in turbulent times like today) rather than the actual cash flows being generated from the securities seems like a poor way of disclosing the financial position of our banking system.

Full Disclosure: No position in BK at the time of writing, but positions may change at any time