Considered by some a major culprit in helping to kill off defined benefit pension funds, mark-to-market accounting is increasingly getting blamed for the economic crisis.
In a panel discussion at the Global Shareholder Activism Conference in London last week, William M. Isaac, chairman of the Federal Deposit Insurance Corp. from 1981 to 1985, called mark to market without a question a major contributor to the current problems this time around.
Mr. Isaac, now a managing director specializing in global financial services at LECG LLC based in Washington, added that mark-to-market, or fair-value, accounting was well intended, but its flat-out wrong.
We have destroyed hundreds of billions of value in our financial system, he added.
In the latest example, Mr. Isaac pointed to a comparison between latest quarterly financial reports of Morgan Stanley and Citigroup Inc., both of which were published last week. The accounting rules allow for banks to count as profit a decline in the market value of their debt because of an increase in credit default swap spreads. Therefore, Citigroup was able to book a profit at a time when investors have less confidence in the bank. In contrast, Morgan Stanley reported a loss because its credit default swap spreads had narrowed, indicating that investors think its less likely to fail.
What is the accounting system trying to tell us? Mr. Isaac said. It tells me nothing.
Lindsay Tomlinson, vice chairman for Europe of Barclays Global Investors, added that at the systemic level, the (mark-to-market) approach falls apart.
Particularly in Europe, mark-to-market accounting has constrained defined benefit pension funds by driving sponsors to match assets to liabilities on a short-term basis even though at least a portion of the pension liabilities are arguably for the longer term.
We will come to realize that we have done something very damaging to ourselves by adopting mark-to-market accounting, said Mr. Tomlinson, who was also part of the panel discussion.
In an interview following the debate, Mr. Tomlinson said he believes mark-to-market accounting have also contributed to the boom when markets were on the upswing by allowing certain assets to be valued too generously.
Financial institutions felt far richer than they really were, Mr. Tomlinson said.
While I dont think mark-to-market is responsible for the current crisis, he added, it is one of several contributory causes.