Why Market-to-Market Accounting is Needed

In lieu of recent event many big name companies have fought against the use of market to market accounting rules. These companies include Goldman sacs, Morgan Stanley, Bank of America just to name a few. Their main rational is that assets or investments that are held to maturity should be marketed to maturity and not to the current asset value. Changing this would have disastrous effects on just about everyone who has stock bonds, or has some kind of retirement fund.

Lets first exam the purpose of market to market accounting. GAAP, the rule makers for all accounting in the United States, Enacted the market to market rules in 2002 for the purpose of having greater clarity on investments help by publicly traded companies. When a asset goes up, the value on the balance sheet also goes up to show a gain on the asset. When an asset goes down, the value on the balance sheet also goes down. This allows investors to see how to value the company with its current asset prices, in case of a liquidation or a sale of the company. As an investor valuations are important and clarity on what assets are worth is important while making decisions on where they invest their money.

Another bonus to the market to market rules is that it makes management value assets at true prices, rather estimate. Some of the biggest and most profitable hedge funds have been using market to market accounting for the at least 20 years and claim some of their success to its use. Many investors also think of safety and using a market to market accounting allows investors to see the worth of a company if the company were to be liquidation as in the case of an Enron scandal or for other rules. Without a fair honest rule, management would be able to mark assets beyond what their really worth and could end up damaging many peoples lives.

Managements of todays corporations are there for one purpose, and this is to make shareholders money. Now with that in mind, if you were trying to increase shareholder wealth, would you want to value an asset at estimated maturity? Which would for sure be higher than the current value? Or would you want to value an asset at its current sale price? Most management would say future value since that will be higher and almost always show an increase in shareholder value. While a market based asset will swing both up and down and could show substantial losses on assets. As a investor which would you rather trust?

Why do these companies feel they need a change in market to market? One of the largest problems with most of these companies is that they have taken very large hits on their asset portfolios due to the market collapse of asset backed bonds. This collapse has forced companies like Bank of America to write down their portfolios and take massive losses. This has caused major liquidity issues and almost caused runs on the banks. Other managements have blamed market to market on the fall of their enterprises instead of the risky business they were in. Again I ask as an investor which would you prefer, trusting management to the asset valuation? Or having a market to market valuation?

The choice is simple. Market to market is the only fair way for investors to correctly value a company without inside information. While most things in life are tilted towards the corporation, it is time that GAAP stands up to them and focuses on the investor and keeps market to market accounting. To leave a final thought, think about this. Would you want to buy a car without knowing everything in it, or if the sales person wouldn’t tell you how much the base value of the car is?