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Fri April 20, 2012
Dr. Jeffrey Burks, University of Notre Dame – Mark-to-Market Accounting
In today’s Academic Minute, Dr. Jeffrey Burks of the University of Notre Dame explains the rationale behind the practice known as mark-to-market accounting.
Jeff Burks is an assistant professor of accountancy and the Deloitte Faculty Fellow at the University of Notre Dame where he researches the financial accounting issues and related public policy questions. He holds a Ph.D. from the University of Iowa.
Dr. Jeffrey Burks – Mark-to-Market Accounting
As we work to reform the financial system after the financial crisis, a practice known as “mark-to-market” accounting has come under scrutiny. Banks claim that it worsened the crisis by exaggerating their losses. Mark-to-market accounting requires banks to report their investments at current market values – values that the banks claimed were irrationally low during the crisis because of panic in the markets. The banks go on to claim that the losses depleted their legal reserves, which forced them to cut lending and spread the crisis throughout the economy.
Prodded by banking industry lobbyists, Congress demanded that the accounting rules be changed. The rules are written by a private board, not a government agency. What Congress seemed not to understand, however, was that, long ago, the government’s own bank regulators had, in many cases, decided not to use mark-to-market accounting. Bank regulators use the accounting only in limited cases, as long as the bank declares that it will hold on to its investments and not sell them at the currently low prices.
I examine the effects of mark-to-market accounting in a study conducted with my Notre Dame colleagues, Brad Badertscher and Peter Easton. We examined 150 large commercial banks and found that mark-to-market accounting had very little impact on banks’ reserves during the crisis. Instead, we found that reserves fell mostly because of bad loans that the banks had made. The losses from bad loans were ten times larger than the relevant mark-to-market losses.
While there are some legitimate concerns about mark-to-market accounting, our findings show that it was not a meaningful factor in the crisis. Our findings also show that much of the Congressional reaction was rash and uninformed, illustrating the need to limit government involvement in accounting standard setting.