AH!!!!! The magic of MtM accounting.

How would you like it if as you spent more on your credit card, the higher your net worth would climb? Well thats the case if you are marking to market (MtM) your debt value. According to this article, the Wall Street Banks are able to do just that.

Banks and other institutions are able to mark to market the value of their outstanding debt and then "book" the difference between the notational value and the market value as REVENUE. The amount of debt owed doesn't change, just the value. As the article states, the banks also use MtM to value assets such as securities, derivatives, etc. and this type of accounting does have merit, but I just can't see the truth through the increased fog this brings to balance sheets, income statements, etc.

For an example of how this works suppose I had $15,000 of credit card debt, a $30,000 savings bond, and I'm paid $20,000 per year. Assuming the simplest scenario my net worth equals my savings bond amount minus my outstanding debt, or in this case 15K. If my yearly expenses matched my yearly income I have a net zero cash flow statement and don't add anything to my net worth. Now lets say I add $1,000 to my debt. This should decrease my net worth by $1,000, correct? But according to MtM, I have increased my annual income (Revenue) by $2,000. What???? Yep that's right I GOT A RAISE by buying that new flat panel TV at Costco. How is this possible you say, well let me tell ya!

Again lets assume a simplified scenario. Your previous debt had a market value of $15,000 because you had an excellent credit record and you had always made good on your debts. People were willing to "buy" you debt for 15K. You weren't risky. But once you bought that TV alarm bells went off in some credit card issuers basement and now you were RISKY. Now no one will touch your 16k of debt for more than 14k. The MARKET VALUE of your debt has decreased 2K (from 16K to 14K). Well according to FASB Statement 159 you can book the decrease in the MtM debt value to revenue. Thats right you "made" 2K more this year. You now show a positive net income of 2K (no other expenses changed throughout the year) and now look good to your investors oh I mean family. If I account for this increase correctly then my "increase" in revenue of 2K minus my increase in debt of 1K adds $1,000 to my net worth. Of course none of these revenue increases adds cash to the bank account but it sure looks good when getting more loans or trying to increase my "stock price".