"The problem with MTM accounting is that it relies on the notion that the market is an asset's best arbiter of value. Most of the time, that's a fair assumption, but it breaks down in a market crisis. When investors are gripped by fear, panic-selling can produce prices way out of whack with underlying asset values. Worse, a market may stop trading altogether.
Even the Financial Accounting Standards Board and the SEC issued a clarification of the accounting rule known as FAS 157 on Tuesday, saying that the price of "disorderly" trades (distressed selling or forced liquidations) isn't "determinative" when measuring fair value. And since it's difficult to imagine a market more disorderly than the one we're in right now, when it comes time to do the books, accountants are basically taking a guess and hoping for the best.
The resulting uncertainty creates a very real problem. The Bank for International Settlements (basically, "the central bankers' central bank") has suggested that applying mark-to-market accounting to triple-A-rated subprime mortgage securities, using the ABX index -- which tracks the current market value of such securities -- as an input, could overstate expected total losses by as much as 60%."
" So what conclusions do we draw? Some possibilities:
• Agitate to have “mark-to-market accounting” outlawed by the Financial Accounting Standards Board. It makes business cycles more extreme, and allows management to play too many games and pay itself too many bonuses. The old system could be gamed too, but not as badly - if you wanted a bonus for an asset’s increase in value, you had to sell it.
• Don’t buy shares of financial service companies with “Level 3″ assets of more than their capital - that’s all the “Big Four” investment banks including Goldman Sachs, Merrill Lynch & Co. Inc. (MER), Morgan Stanley (MS) and Lehman Bros. Holdings Inc. (LEH), and most of the big commercial banks, too. Those Level 3 assets are probably worth very little in a real downturn, because there is no market for the assets and everybody else will be trying to sell them too.
• Expect more unexpected crashes and taxpayer bailouts. The mark-to-market system is highly unstable, and the value of illiquid assets can vanish in a downturn.
• Treat “mark-to-market” accounts with deep suspicion unless all the assets so valued are publicly traded on a recognized exchange. "