Worthwhile Canadian Initiative explains how mark-to-market accounting is flawed:
The wisdom of MTM [mark to market] accounting has been debated before and since its original implementation. On the one hand, it “shines a light” on developing asset value problems. On the other, it has the potential to exaggerate volatility in reported earnings, in some cases unnecessarily. As a simple example, a 5 year fixed rate loan or bond that matures in tact may exhibit substantial MTM volatility throughout its lifetime. But such volatility accumulates to zero net effect by the time the bond matures. ...If mark-to-market accounting can overstate an asset's value during a bubble, it can understate its value during a panic. For international banks, which have some or all of their assets subject to mark-to-market accounting, the difference between accrual accounting and mark-to-market accounting can be the difference between solvency and insolvency.
A relevant and connected analogy exists in the household sector. The housing boom was based on easy credit and an implied belief in MTM accounting for houses, otherwise known as the ATM effect. Current house prices, however inflated, were the basis for many hundreds of billions of dollars of mortgage equity withdrawals (MEW). Those who bet on housing MTM as an indicator of sustainable price appreciation behaved accordingly. So did mortgage lenders. Those who restrained from using MTM as a mental accounting of a sustained trajectory of personal wealth, and who considered such MTM information with more restraint, probably checked their behaviour more wisely in terms of allowing for risk. In order words, behaviour was a function of how households viewed the effect of housing MTM on their personal balance sheets and longer term capital positions. Those who resisted incorporating full MTM into their own capital evaluations were probably more restrained in MEW transactions and related spending. Those who acted aggressively on their housing MTM profile overextended their balance sheets and spent the money from their MEW proceeds.
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