Today the Financial Accounting Standards Board (FASB) voted to ease one of the accounting standards that is used in the complicated process of determining the value of assets owned by financial institutions.

When this happened the Dow Jones Industrial Average immediately traded up about 300 points and certain stock market pundits began proclaiming "The Depression is over!"  -  clearly, this decision was important and we will attempt to explain why:

The business health of financial institutions is measured by the value of the assets they own.  When a bank makes a mortgage loan it puts forward the money to buy the house and allows you to live in that house and call it yours as long as you make timely mortgage payments according to your mortgage agreement.  Your house is pledged to the bank as collateral for your mortgage loan, which means that if you do not pay your mortgage the bank will claim ownership of the house.

The fully collateralized and current paying loan is an asset for the bank and it has a market value.  If you do not make your mortgage payments, your loan declines in value but that value is replaced by the value of the collateral, your house.  One way or another, the bank will eventually get most if not all of its money back either through you paying off your mortgage or through the bank reposessing and selling the house.

Some banks are considered healthier than others and this impacts their ability to borrow and their cost of borrowing money just as your own credit score impacts your ability to borrow money to buy a car or house.  As mentioned above, the health of the bank depends on the value of the assets it owns.

During times of financial crisis the market value of these assets will temporarily decline and that can damage the bank's ability to borrow money to finance its operations because, until today, the bank was required to state the value of its assets according to what the current market would pay for them.  When the market value of a bank's assets declines,  it is said that the bank's capital position has weakened  - and it doesn't matter whether this weakening is only temporary due to a crisis. 

The idea of marking-to-market during times of crisis means that the bank may not be able to get back the money it has loaned if it has to immediately sell off its assets, even though over time it may still be able to recover all of its money by either waiting for the loans to pay off, selling the loans, or selling the collateral.   In truth, there may be no reason to sell off these assets and therefore there is no real need for the bank to worry that it won't get its money back.  As soon as the crisis is over, the assets may return to their previous value and all will be well.

When Fed Chair Bernanke and Treasury Secretary Paulson marched into a meeting with top Government officials and told them unspeakable tales of financial collapse and ensuing misery, what prompted this action was the market-wide realization that if banks and certain other institutions were to mark their assets to market, their capital positions would look extremely weak and their creditworthiness would be greatly diminished.  In other words, their normal borrowing activities became impossible because they were forced to value long-term hold assets at current market value.

Since the FASB eased the mark-to-market standard to allow financial institutions to mark long-term hold assets to a valuation model that more accurately reflects their true value over time, it has suddenly resulted in an improvement in the capital positions of most of the major financial institutions.  This should help to ease the credit crisis and allow funds to return to a more normal flow between financial institutions and, eventually, should result in their ability to work out some of their problem loans rather than write them off immediately.

So easing mark-to-market restrictions has helped ease the current financial crunch, but the reason the mark-to-market provision was created in the first place was the tendency of banks and other financial institutions to assign totally unrealistic values to their non-performing assets in order to keep the dismal condition of their capital position secret.  That is why, amid all the optimistic talk today, you are also hearing from people who are proclaiming that changing the mark-to-market rules will allow the financial institutions to misrepresent the soundness of their financial health.