Economics has always mystified me, but watching the death spiral on Wall Street this past week has left me even more baffled than usual. I don’t pretend to understand what’s happening. But this morning I’ve begun to wonder if maybe—just maybe—there are some aspects of this debacle that I fail to understand not just because I’m thick but because they actually don’t make sense.
The part that’s puzzling me right now is an accounting rule known as “mark to market.” If I understand correctly, the gist of the mark-to-market principle is that the value of a thing is whatever you could get for it if you were to sell it right now. “Fair value” = “current exit price.” For some kinds of assets there’s a longstanding tradition of assigning value in this way, but in the past year the rule has been applied much more broadly. (See Rule 157 of the Financial Accounting Standards Board, which took effect November 7, 2007.)
Is it really a good idea to equate price and worth quite this rigidly? I’m not trying to overturn all that adamsmithian capitalist orthodoxy about a willing buyer and a willing seller and an invisible hand. And I understand that mark-to-market was introduced as an improvement over the mark-to-wishful-thinking kind of accounting that led to the previous round of scandals, such as Enron. Still, could it be that we’ve gone too far?
Consider the guy who sells umbrellas on the sidewalk around the corner from the New York Stock Exchange. Under mark-to-market rules, his inventory is assigned a much higher value on rainy days and becomes nearly worthless when the sun shines. I suspect that the umbrella guy has a very clear understanding of how the weather affects his business, and yet he doesn’t just throw away all of his stock whenever the sky turns blue. He knows that under those conditions he can’t sell an umbrella at a profit, but he still considers the umbrella to have a certain intrinsic worth. He hangs on to it. He carries it on his books as an asset. This concept of inherent value is apparently too sophisticated for the traders inside the exchange. In that world, if the Emir of Dubai doesn’t need an umbrella on Monday, then all umbrellas are “toxic.” But if the Secretary of the Treasury asks for an umbrella on Friday, then everybody invests in umbrellas.
Surely I’m missing something. It can’t be this stupid.