Did “Mark-To-Market” Rules Cause The Financial Crisis?


by Gary D. Halbert

September 18, 2018

  1. “Mark-To-Market” Versus “Historical Cost” Accounting
  2. Mark-To-Market Accounting and the Great Financial Crisis
  3. FASB Relaxed Mark-To-Market Rules in March 2009
  4. Surprise: Trump’s Tax Cuts Help Low Wage Workers the Most


Q2 hedge fund letters, conference, scoops etc


Last Saturday, September 15, 2018, marked the 10th anniversary of the Lehman Brothers bankruptcy, which set off the worst US financial crisis since the Great Depression. It was the largest bankruptcy filing in US history, with Lehman holding over $600 billion in assets.

Lehman was the fourth-largest US investment bank at the time of its collapse, with 25,000 employees worldwide. Lehman’s collapse was a seminal event that greatly intensified the 2008 global financial crisis.

The bank had become so deeply involved in mortgage origination that it had effectively become a real estate hedge fund disguised as an investment bank. At the height of the subprime mortgage crisis, it was exceptionally vulnerable to any downturn in real estate values.

The bankruptcy triggered a one-day drop in the Dow Jones Industrial Average of 4.5%, the largest decline since the September 11, 2001 attacks. It also ushered in the worst recession since the Great Depression.

The 10th anniversary of Lehman’s bankruptcy has also reignited the debate on whether the implementation of “mark-to-market” accounting rules in late 2007 – which resulted in large losses for many commercial banks – triggered the financial crisis. In retrospect, many analysts and forecasters believe the answer is YES. Count me as one who agrees that mark-to-market was a huge factor in causing the financial crisis.

My sense is that most investors don’t really understand mark-to-market accounting, much less whether or not it caused the financial crisis, so that’s what we’ll talk about today.

“Mark-To-Market” Versus “Historical Cost” Accounting

Without getting too far out in the weeds, here is a brief summary of mark-to-market (MTM) accounting. My apologies to the CPAs and accountants reading this who know far more about MTM than I ever will.

Mark-to-market accounting refers to accounting for the “fair value” of an asset or liability based on the current market price, or the price for similar assets and liabilities based on another objectively assessed current “fair” value. The key word is current.

MTM differs from “historical cost” accounting which is often based on what was paid for the asset or similar past transactions. Historical cost accounting is simpler, more stable and easier to perform, but it usually does not represent the current market value. Many large banks used this form of accounting until MTM was mandated in late 2007 and banks had to write-down the value of some or all of their assets, especially illiquid assets.

Mark-to-market accounting can change values on the balance sheet as market conditions change. Thus, MTM accounting can become volatile if market prices fluctuate greatly or change unpredictably. This caused major problems (write-downs) for many banks in late 2007 and 2008.

Mark-To-Market Accounting and the Great Financial Crisis

Many factors came together to make the financial crisis happen. Overinflated home prices and questionable lending were two of the pre-conditions, but they weren’t the actual tipping point. The tipping point was a new accounting regulation from the Financial Accounting Standards Board (FASB) that was implemented on November 15, 2007. FAS-157, also known as the “mark-to-market accounting” rule, was a ticking time bomb.

A week before FAS-157 went into effect, financial journalist Stephen Taub warned: “If you think banks are writing off large amounts of assets now, wait until new accounting rules take effect this month.” He was spot-on.

That rule change required financial institutions to update pricing of illiquid securities. That led to write-downs in many financial derivatives including credit default swaps (CDS), mortgage-backed securities (MBS), etc. And ultimately, some big banks became insolvent, including Lehman Brothers.

The stock markets began a nosedive just as FAS-157 went into effect, as you can see below. The S&P 500 Index plunged over 50% in the next few months, and the world watched in disbelief. A global financial crisis worse than anything since the Great Depression unfolded.


Trillions of dollars in wealth disappeared. The crisis required a write-down of over $2 trillion from financial institutions alone, while the lost growth resulting from the crisis and ensuing recession has been estimated at over $10 trillion (over one-sixth of global GDP in 2008).

The year 2009 became the first on record where global GDP contracted in real terms. The process of responding to the crisis, the subsequent deep recession and the impacts on governance of the global financial system took the better part of the decade to implement before there was a reliable return to growth across the US and Europe.

FASB Relaxed Mark-To-Market Rules in March 2009

On March 16, 2009, the Financial Accounting Standards Board proposed more lenient guidelines for valuing assets under FAS-157. That was the same month the stock market bottomed. The recession officially ended shortly thereafter, but the global financial system remained in shock.

Millions of investors had been spooked out of the stock markets prior to the bottom in March 2009, many of whom have never returned and thus, missed out on the powerful bull market that followed to this day. Millions were forced to delay retirement, or in many cases, go back to work in a dreadful economy. Millions of Americans lost their homes. The unemployment rate soared to near 10%.

The US government under President Obama engineered a $787 billion stimulus package to rescue the economy in 2009. Opinions on whether the stimulus worked or not continue to this day. Some say it prevented another Great Depression. Others argue it was a colossal waste of federal money. I tend to fall in the latter camp.

In conclusion, there are many opinions on what caused the great financial crisis and the bankruptcy of Lehman Brothers. As noted above, numerous factors collided to cause the crisis. Yet in my view, the implementation of mark-to-market accounting rules in November 2007 was the proverbial straw that broke the camel’s back and launched us into the crisis.

That is not to say that mark-to-market accounting rules are necessarily bad. In the case of late 2007, however, the timing of MTM implementation couldn’t have been worse. The economy was leveraged as never before; home prices were in a bubble; and banks had aggressively lent to millions of Americans who should not have qualified.

Finally, in November of 2007, when the voters elected Barack Obama president, our national debt was around $9.5 trillion. Today, it’s nearly $21.5 trillion. And the Congressional Budget Office projects the annual federal budget deficit will reach $1 trillion in FY2019 and remain there for several years – and this assumes no recessions, which is ridiculous.

I mention these troubling facts only because people often ask me if I think we’ll have another financial crisis in the future. My answer: “ABSOLUTELY!” And it could be worse.

Surprise: Trump’s Tax Cuts Help Low Wage Workers the Most

Last week I wrote about the surprisingly strong jobs report for August that came out on September 7th. That report from the Labor Department showed 201,000 new jobs created, the unemployment rate holding steady at 3.9% and a 2.9% increase in average annual wages.

Now we’ve all heard the liberal media complain that President Trump’s corporate tax cuts benefited mainly “the rich,” and that lower paid workers got hardly anything. Well, a deeper dive into the August jobs report proves that’s just not true. Here are some uplifting facts from the Labor Department report that the media chose to ignore.

Fact #1: Total wages rose 5.1% in the last 12 months. To calculate “total wages” the Labor Department factors in the hourly average earnings and total hours worked. Total hours worked has been steadily rising as the economy has heated up. Together, they rose 5.1% over the last year.

Fact #2: Top 10% saw the lowest wage growth. Despite media buzz to the contrary, the top 10% of workers saw wage or salary increases of only 1.2% on average in the last year – compared to a 3.9% average rise for workers in the bottom 10%. Earnings for workers who never finished high school were up 7.6% in the past year, faster growth than for any other educational category.

What, you didn’t hear about this? Be sure to read the “Wage Growth…” story in SPECIAL ARTICLES below.

Put it all together and we have a labor market that is already tight and set to get tighter. Back in June, the Federal Reserve projected an average unemployment rate of 3.6% in the 4Q of this year and 3.5% in 2019 and 2020. Based on the current trend, the jobless rate could be even lower, and it’s benefiting the lowest paid workers the most.

The bottom line is that the media is either too lazy to dig out these facts, or more likely, they don’t want us to know. I’ll bet it’s some of both! Just thought you should know. I’ll leave it there for today.

All the best,

Gary D. Halbert


Wage Growth Benefits Low Income Workers Most, Highest Paid Least (Must Read!!)

Mark-To-Market Accounting – How It Works, Pros & Cons

Mark-To-Market’s Role in 2008 Financial Meltdown

Gary’s Between the Lines Blog: Small Business Optimism & Household Income Hit Record High

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