Marky Mark Accounting

Somewhere in the murky depths and lofty heights of the last quarter of the Twentieth Century, the accounting profession and I lost track of each other, and apparently they lost their way.
I’m referring to an abstruse principle called mark-to-market accounting, which I’ll call “marky mark accounting.”

The accounting profession dates its toolkit – double-entry bookkeeping – back to a late 15th century Venetian monk named Pacioli. Since then, accounting has become a profession, complete with a unique body of knowledge, supporting educational programs, a qualifying process, a code of ethics, and a supporting organization. In the US, that supporting organization is the American Institute of Certified Public Accountants (AICPA). Their Financial Accounting Standards Board (FASB) publishes authoritative accounting and reporting standards for businesses and various levels of government. These standards are based on generally accepted accounting principles (GAAP). Every accounting student learns the GAAP and the GAAS (generally accepted auditing standards).

One of the cornerstones of GAAP is the cost principle, which basically says that you carry an asset on the books at the price you paid, or, if otherwise acquired, at the fair market value of what the asset would have been worth at the time you acquired it. You do not realize any gains or losses as its market value fluctuates over time. Only when you book a transaction, such as when you dispose of the asset, do you compute gain or loss. Of course, if it’s patently obvious that the asset has become worthless, you would “write it down” then, but even that is in fact a transaction.

What about cars and computers and oil wells? Well, there is something called depreciation (or depletion, in the case of natural resources like oil) that exists to illustrate the decrease in value of depreciable assets over time. Even then, we do not touch the book value of the asset; the depreciation account is a separate account that “offsets” the book value (these are called contra accounts). Because of another GAAP known as conservatism, there is no such corollary as an “appreciation” account to illustrate the masterful business acumen of our management team as it brilliantly acquires assets that do nothing but increase in value.

OK, so now someone please explain to me how it is that financial institutions were somewhere along the line allowed to “correct” the book values of assets such as real estate in the absence of a disposal or other transaction that objectively set the actual value? I’ll bet Wall Street managers were right proud of themselves as their balance sheets – and their bonuses – swelled with the marky mark fantasies. No one would ever believe that these very same priceless assets would one day approach worthlessness.

As they indeed have.