We Can Thank The Late Ken Lay And Bernie Ebbers for some of the mess our financial system is in now. I'm talking about mark-to-market accounting, a reform attempt brought in by the Sarbanes-Oxley law in an effort to prevent accounting frauds like the ones perpetrated by Enron and Worldcom. Before Sarbox, companies based valuations of many assets on expected cash flows, and this sometimes meant marking to a financial model. In the wake of those frauds, marking financial assets to market prices seemed to be the fair thing to do on a balance sheet. Market prices seem less susceptible to manipulation than prices coming out of a financial model. It seemed fair, that is, until last summer, when credit markets seized up, and no one was willing to buy derivatives, mortgage-backed securities or even commercial paper. Asset values plummeted, companies collapsed and so did confidence in our financial markets.rnTo illustrate what's going on, here is what mark-to-market would mean to your home mortgage. Let's say a few years ago you bought a house and put down a healthy down payment. You like your house and have no intention of selling, and you are paying your mortgage every month. But let's say houses in your neighborhood have been selling for much lower than they did when you purchased your home. Suddenly your home's value is less than the amount you owe on your mortgage. Now, as long as you keep paying the mortgage, the bank should be fine, right? Not so, under mark-to-market rules. In this scenario the bank would have to assess what that underwater mortgage might fetch in a distressed sale and ask you to make up the difference.
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