Mark to Market from an Accounting 101 perspective
October 9, 2008
Two Biblical principles -- a law and a judgment, respectively -- are the foundation for free market economics (1) thou shalt not steal (Ex 20:15), and (2) Thy silver is become dross … I will turn my hand upon thee, and purely purge away thy dross (Isa 1:22a & 25a).
Before we apply the principles let's have an accounting lesson. (This is also a cure for insomnia.) In accounting, one of the main functions is determining the value of a company. This is done internally by the company's accountants and externally by the auditors for verification.
When we see the inventory folks crawling around the floor of the local Walgreens, or Eckerds with counting machines counting the quantity of every item in the store what they are doing is verifying that the company is accurately stating the value of their inventory. This inventory is an asset on their books. The company must state the value of its assets accurately and their auditors must verify the value of these assets.
Once all of the assets are verified then and only then will the financial statements accurately state the value of the company. These financial statements are the basis upon which investors, creditors, and potential buyers make their decisions.
In addition to inventory this same verification is done to all assets of a company including the physical land and buildings to determine their value. In the same way as those buildings, your home (if you have a mortgage) is on the books of the lender. In order to value that asset the 'mark to market' method is a key valuation metric. In the same way that a realtor would determine a good sell price for your home by looking at comparable homes in your area companies holding mortgages look at comparables and then mark up or down the value according to the current comparable selling prices. The great part about this method is that it is verifiable. The difficult part is that even though I have a mortgage contract with a buyer that is paying I have to reduce the value of the home/asset to what I could sell it for now upon default or foreclosure.
A new further difficulty is created by the securitizing, i.e., rolling a bunch of mortgages into a commercial instrument. We should now call these IEDs (Instrument of Economic Destruction) because the act of bundling the mortgages together makes marking to market extremely complicated for the holder who is too far from the actual properties. (This may even have been the goal of those who created the instruments in order to ignore risks associated with property value and credit-worthiness of mortgagee in order to just sell at an unrealistic maximum value.)
To the principles … (1) Thou shalt not steal. Applying a value to assets that is incorrect is fraud, dishonesty, theft. When it is suggested we abandon 'mark to market' we are being tempted to ignore God's law. (2) Thy silver is become dross … I will turn my hand upon thee, and purely purge away thy dross. If we don't sort this out ourselves God will judge us and sort it out for us.
The current suggestions we are hearing to "temporarily" suspend mark to market are yet another attempt to see if two wrongs can make a right and if we can just wait and do the right thing later. We hear the same failed reasoning from recovering alcoholics and drug addicts. In order to sort out this mess we are in we need mark to market reality.
I will leave us with this question. Would we buy a gold coin for which we did not know the percentage of gold it contained?