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Midterms and mark-to-market

Grace Concelman | Tuesday, October 11, 2011

Midterms. That week directly preceding fall break when everyone has 12 exams, four papers, two presentations and a problem set due. No one likes midterms.

You know what else no one likes? Accounting. All of you accounting majors out there can jabber all you want about job security and how much you like financial statements, but eventually the truth will come out. Accounting is like your Great Aunt Mildred: boring, fussy and smells a little like a dusty basement.

Okay so the last part might not actually be true, but at least we can establish that no one really likes accounting. Accounting and midterms are things we endure because someone, whether it’s our professor or the Securities and Exchange Commission, says we have to.

General animosity is not the only way midterms are a lot like accounting. Specifically, midterms are a lot like mark-to-market accounting. Mark-to-market is the practice of accounting for assets and liabilities at current market prices or some other objective “fair” value.

Under mark-to-market, if you bought a futon three years ago, you would value that futon at whatever price you could sell it for today. Which, given the ways college students typically abuse futons would likely be much lower than the price you originally paid.

This seems reasonably intuitive. The alternative is historical cost accounting, which values assets and liabilities based on past transaction prices. Using historical cost, you would value your futon at the price you paid three years ago.

So how is mark-to-market a lot like midterms? Midterms are when we mark our semesters to market. Like it or not, they force us to revalue our expectations of our grades and base them on how much we’ve actually learned over the past eight weeks rather than our hopeful assumptions that we have picked something up from sitting in class and flipping through the book.

Since we don’t like midterms, should we also not like mark-to-market? It seems so straightforward and fair, but at the same time it’s kind of unnerving.

What if the market isn’t where we want it to be? What if your Theology TA is an unreasonably difficult paper grader or if your math teacher doesn’t set a curve until the end of the semester? What if you aren’t feeling well during the test, or if there’s another weather-related emergency? When conditions are such that market prices (your grades) aren’t good estimates of actual value, marking-to-market seems a whole lot less fair.

Mark-to-market was a controversial topic during the recent financial crisis. When markets were going up, valuing assets at market prices wasn’t a problem. But, when the bubble burst and stock and bond markets plunged worldwide, the market prices of everything fell too, and some markets disappeared completely without willing buyers or sellers. Suddenly, the assets firms held were worth a lot less. Banks were forced to sell their assets at the low prices simply because they needed cash to continue operating, which only exacerbated the problem. Several rounds of failures, mergers and bailouts later, people wondered if mark-to-market rules were partially to blame for the severity of the crisis.

While mark-to-market might not be an appropriate measure of value in periods of crisis or high volatility, it is hard to see how a different method would be better. As much as we may not like the roller coaster reality mark-to-market forces us to face, it is, in fact, reality, and it would be hard to argue that banks and other investors should operate outside of reality. Mark-to-market is a useful benchmark because sooner or later we’re going to have to take that final exam.

See, midterms aren’t so bad after all.

 

Grace Concelman is a senior majoring in finance and philosophy. She can be reached at gconcelm@nd.edu

The views expressed in this column are those of the author and not necessarily those of The Observer.