http://www.myhowtoos.com/en/red-hot/50-how-long...

First, people should understand that for mortgage loans, a company is NOT required to use mark-to-market accounting. In fact, companies could NOT do it until FAS 159 was issued.

Second, people should understand that companies make an election upon acquisition of a security whether they will use mark-to-market accounting or use amortizing cost. This is a one-time election based on intent, or lack thereof. If the company intends to trade in the security, they have to use fair value accounting (which is mark-to-market). If the company intends to hold the security until maturity, they have to amortize the cost of the security over the life of the security. The third option, is the option to not take a position, which is called “available-for-sale”. This is akin to how most individual investors look at their net worth, in that you consider the value of the security in your net worth, at it's fair value, but you do not treat gains as income or losses as loss until you sell the security. Most companies take this position because accounting firms don't take kindly to saying you're going to hold something until it matures, but then sell it. Since they can't trust your stated intent, then all your “held-to-maturity” securities have to be treated as available-for-sale.

What had happened in the past is that companies would use market prices when the price was to their favor, but they would use their own internal modeling of the cash flows when the price was against them. With the implementation of FAS 157, that was no longer feasible.

FAS 157 requires companies to state how they are calculating the fair values used for their books. Level 1 is based on quoted market prices. Level 2 means that the value is based on quoted market prices, but since the market price is for something similar and not exact, it's not as strong as Level 1. Level 3 means that the value is based on an internal model, using internal assumptions. This is sometimes derisively called “mark-to-magic”. The accounting firms and the SEC look down upon Level 3, and FAS 157 requires much more disclosure about how the values were determined. Further, the SEC has been fairly strong in stating a comapny should use the most accurate means possible, meaning Level 1 where possible.

Companies are not used to this type of disclosure, and they make the claim that using Level 1or Level 2 in an illiquid market is tantamount to an artificial price and does not indicate a “regular-way” price (a requirement of FAS 157 is the price is not based on stressed prices due to required liquidation).

An illiquid market is a sign that the price has not yet reached its equilibrium price, but the market is being made illiquid by investors who do not want to part with their assets at low prices. Further, this market is being made even more illiquid because of these bailouts, both private and public, that are occurring, as we do not get the luxury of seeing what these assets would fetch in an open market auction. If those securities were sold to bidders, rather than assumed by JPMorgan we could see what the actual fair value is of these.

That said, I do not see the banks lining up to buy like securities at the “net present value of the cash flows”. I would ask every company that is clamoring for this: “Would you buy this security at the value that you show it on your books?” If they say yes, have them prove it by buying an extremely similar security at that price. They won't do it, because they know that right now, the credit premium is too high and they feel they could get it for cheaper. If they feel they could get it for cheaper, why do they think their security is worth more?

Finally, I didn't see these companies shouting “wait! the fair value of my security is too high! It should be lower!” If the market is undervaluing these securities now, then it was undoubtedly overvaluing them before. If they want to go to the PV of cash flows method, then they should have to restate their earnings for the past 5 years using this for all their debt securities.