On Thursday, the Financial Accounting Standards Board agreed to relax the accounting rules that require banks to mark their assets to market. Marking to market is the practice of using the current market price, rather than an historical value-or, in the case of many toxic assets, a guess-to represent the value of an asset owned by the bank. The banks have been clamoring for this change for months, for a simple reason: being marked to market sucks.
And that's not just true for banks. Economics, and life, are full of situations in which our assets are marked to market, and in general, the results are painful. Homeowners, for example, always seem disappointed at the price their house sells for. Students dread being marked to market in their courses (using a curve is mark-to-market grading), and then they face another sobering mark-to-market when they search for their first full-time jobs. And let's not even get started on the marriage market.
The judgment of the market always seems especially harsh when it comes to valuing our own cherished assets, and in many cases its verdict seems downright unfair. So it's no wonder that banks, and people, vastly prefer to avoid using market values and rely on their own models instead. Here are a few notable examples of this.
"We believe these loans have outstanding long-term value."
"I understand the concepts."
"I'm an excellent driver."
Another impulse is to hide from the market temporarily and wait for it to somehow change its mind about the value of our assets.
"The markets are too illiquid right now to provide credible prices."
"This one-year Masters program in Nothing-in-Particular will make me more marketable next year."
"Bald will be sexy again someday."
But like it or not, the market is our reality check. We need to hear, and react to, what the market is telling us about the value of our assets. A down market, like the one we're in, causes buyers to examine the assets for sale especially carefully. This extra scrutiny gives asset sellers perhaps their most honest feedback on what the true value of their assets is, and what features of their assets need to improve. When the market is slow to recognize the true value of an asset, or its prices seem unfair, it is often the case that the asset seller is not doing a good job of conveying the asset's value to the market, or is trying to sell their asset in the wrong market. And even when the market seems to be dysfunctional, it often gets that way because of problems in the assets themselves.
The markets are far from perfect. But trying to substitute your own subjective judgment for the market's valuation, or trying to wait out the market for better times, leads to worse outcomes than working with the market. Avoiding the market means missing out on the feedback that could actually help you repair or improve your assets' value. It also sends a strong signal of its own to the markets: that you think you have something to hide, or aren't confident in the value of your assets, so that your assets may still be discounted even after the market recovers. Worst of all, it prevents you from getting on with the real business of life, which is to make the most of your assets, no matter what shape they are in today.
Connel Fullenkamp is the associate director of undergraduate studies for economics. This is his final column of the semester.
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