Mark-to-Market Pricing: A Middle Ground

Abstract

Statement of Financial Accounting Standards No. 157, Fair Value Measurements, was intended to improve fair value accounting by eliminating “diverse and inconsistent practices,” especially for items that are not actively traded, by requiring companies to value their assets based on market realities rather than financial projections or estimates. But critics have called for suspension of the standard until the market for mortgage-backed securities stabilizes. A different alternative would be to create flexibility in the standard so financial firms would have the ability to differentiate between bonds that were credit impaired and those that were liquidity impaired. By allowing financial firms to make such a distinction, the revised standard would help prevent the type of death spiral that has forced dozens of entities, including venerable banks and hedge funds, to sell their assets in illiquid markets at depressed prices.

TOPICS: Portfolio construction, portfolio theory, fixed income and structured finance