Volcker and Greenspan: Mark to Market

Paul Volcker on Mark to Market Accounting

Former Fed Chairman, Paul Volcker, Chairman of the Group of Thirty, Consultative Group on International Economic and Monetary Affairs, Inc., just released a study with recommendations on financial reform.

Recommendation #12 on Fair Value Accounting reads as follows:

"a. Fair value accounting principles and standards should be reevaluated with a view to developing more realistic guidelines for dealing with less liquid instruments and distressed markets.

b. The tension between the business purpose served by regulated financial institutions that intermediate credit and liquidity risk and the interests of investors and creditors should be resolved by development of principles-based standards that better reflect the business models of these institutions . . . ."

Alan Greenspan on Mark to Market Accounting

On November 1, 1990, Federal Reserve Chairman, Alan Greenspan, in a 4-page letter to Richard Breeden, Chairman of the Securities and Exchange Commission, said, in part:

"The Board believes that market value accounting raises a substantial number of significant issues that need to be resolved before considering the implementation of such an approach in whole or in part for banking organizations.

Accounting methodology should be developed to measure the results of a particular business purpose or strategy; it is not an end in itself. For an institution whose business purpose is to trade marketable financial assets on an intra-day basis, for example, closing daily market values would measure the success or failure of that particular business purpose. An end of the day balance sheet, marked to market, is clearly the appropriate accounting procedure in the example.

Generally, the business strategy of commercial banks, on the other hand, is to employ their credit insights on specific borrowers to acquire a diversified portfolio of essentially illiquid assets held to term. The success or failure of such a strategy is not measured by evaluation such loans on the basis of a price that indicates value in the context of immediate delivery. Clearly, one aspect of value in an exchange is the period of delivery. Bu the appropriate price for most bank loans and off-balance sheet commitments-is the original acquisition price adjusted for the expectation of performance at maturity. It is only when that price differs from the book value of the asset that an adjustment is appropriate.

A reserve for loan losses is such an adjustment. To mark such an asset to a market price intended to reflect the value of a loan were it liquidated immediately is interesting, but not a relevant measure of the success of commercial banking."