Mark to Market Accounting and the Bankers on Greedsville
04/08/2009: 
Demand and supply is what drives the markets today and has always been the reson for the markets to act in the manner they do. The theory of demand and supply applies to everything from the restaurants we pick to the cars we drive, from the equities we choose to the “complicated” derivatives we choose to neglect.
There are two sides to a coin and this applies to the application of the FAS 157 Mark to Market Accounting Rule as well.
Lets consider the scenatio in which the M2M Rule was removed. If this is the situation in a bear market you would probably see the people on Wall Street celebrating throughout the recession. There was a time when the same Wall Street bankers invested in high-risk, high-return derivatives with the hope that things dont turn sour some day. Unfortunately, when they loaded up their balance sheet with these assets (so to speak), the mortgage crisis erupted. This lead to almost all of these high-risk assts getting negatively affected due to their direct corelation with the mortgages. This is where demand and supply comes into play, why would any counterparty purchase these assets when they know that the risk factor of these assets has risen considerably, leading to a drastic drop in demand of these assets. Every bank wanted to dispose off these asses from their balance sheets and thereby raising the supply of these assets. In a typical scenario when supply exceeds demans, the value of the assets decline. According to the FAS 157 Rule, the bank must report the fair value (i.e. the value the market is willing to pay for the asset) of the asset on their balance sheet. This will result is a true representation of the actual value of these “toxic” assets and will cause a serious dent in the balance sheet of the banks. But, if the M2M Rule is removed then the true value of the asset is kept hidden from the public, which means that there is no way to rightfully value an entity that carries these toxic assets. Although this rule is good for such entities because they dont have to write off these assets and can value them at a much higher level than what they are truely worth, it is not such a sweet deal for 
investors.
Now, for the sake of argument lets consider the scenario in which the M2M Rule was continued. This will result in the banks writing down these assets or selling them to the government. If the government buys these assets from them ,they would have to buy it at a premium to what they would have been sold for in the open market, thereby adding more weight to the right hand side of the government’s balance sheet. These expenses would have to be funded from the tax payers money, which is yet another raw deal for the tax payers. The reason I say that they will have to buy it at a premium is because, if they buy it at the fair market value then the banks would have to report a huge loss for these assets sold, thereby decreasing their asset base. The asset base is important because the banks make loans on the amount of equity it owns, more loans will result in more revenues and more the profitable the banks become.But, on the other hand if their assets reduce and they maintain the 4% reserves that they are required to, then they will have lesser equity to use in making new loans, thereby reducing their profitability. If a bank finds it hard to “make ends meet”, they will have to seek government help in the form of a bailout. A bailout simply means that the government will use the tax payers money and the money in the Social Security Trust to fund banks that have ended their journey on “Greedsville”. Therefore, who is getting the benefit of the Rule and who is getting the boot? The banks that got us into this mess in the first place are getting the benefit of the Rule and we, the tax payers are bearing the grunt of the whole situation by being mere spectators.
In conclusion, either way the investors will have to bear with the mess created by the Bankers of Greedsville. But, keeping in mind the governments growing current account deficit, I would think a temporary suspension of the Rule will be beneficial to both the banks and the investors. The only drawback in temporarily suspending a Norm is that is takes on a more permanant stand in the long rule. What I mean by ths is there will be lobbyists who will try to make this Rule suspension permantly stick.