Isn’t Marking to Market Supposed to be a Good Thing?

OK, I’m trying to get my head wrapped around this whole market meltdown thing. One of the things that has puzzled me is seeing complaints that some of the various bailouts have been triggered in part by regulations that force companies to mark mortgage-backed securities to market — that is, to account for changes in the value of the securities they own when market conditions change.

I seem to recall that prior meltdowns were caused in part because financial companies did NOT mark to market, but rather carried securities on their books at artificially high prices after market declines (and then borrowed against those inflated securities).

So here’s a good explanation of the problem with mark-to-market accounting in volatile circumstances (hat tip: Iain Murray):

Imagine if you had a $200,000 mortgage on a $300,000 house that you planned on living in for 20 years. But a neighbor, because of very special circumstances had to sell his house for $150,000. Then, imagine if your banker said you had to mark to this “new market” and give the bank $80,000 in cash immediately (so that you would have 20% down), or lose your home. Would this reflect reality? Not at all. Would this create chaos? Absolutely.

The original article also answers the question in my headline:

Mark-to-market accounting is a good thing. It makes sense most of the time for most financial instruments that are traded frequently and openly. But there are special circumstances, and today’s financial market problems would meet any definition of the word special.