Setting the value – accounting rules

One of the major factors in the bank problems has been the ‘mark to market’ rule. That forced banks to value their mortgages based on what they could sell them for at a particular time. The issue is that this doesn’t consider the actual health of the mortgage nor does it consider the bank’s ability to hold its assets for either a completion of the mortgage terms or a better market for selling the mortgage as a financial instrument.

Mark-to-market distorted the market by forcing banks to take losses on mortgage assets even if the underlying loans were still performing, based on the last fire sale price of similar assets. [Iain Murray]

What happened with this rule is that a blurp in one corner was reflected in the whole realm. That made the institutions holding certain classes of financial instruments appear to have much less value than they might really have had.

The difference is somewhat like the difference between those who bought a house as an investment and those who bought a house to live in. If you bought the house as an investment, a drop in its market value is the issue of concern. If you bought the house to live in, the actual value at any point of time is of no interest as long as you can keep up with the mortgage payments.

With that rule relaxed, the stock market responds positively. People can value financial instruments for what they can do – as in providing a place to live in the case of mortgages – rather than in what someone might be willing to pay for them.

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