Mark-to-market Accounting and the Credit Bubble

Naked Capitalism comments on the idea that Mark-to-market accounting contributed to the credit crisis. The argument made is that by marking the money to market they can grow their capital bases which allowed them to use more leverage.

It should be clear to most observers that credit bubbles are created by interest rates below the natural rate. In this case low interest rates drove higher home prices. Obviously this made securitized debt appear less risky than it should have been which kept the equity and mez tranches spectacularly overpriced.

I suppose I should go on to say that mark-to-market still would make sense for things that are actively traded or things that are strongly correlated with things that trade actively. However, the question comes to whether assets that do not trade actively should be marked-to-market?

Most securitized debt does not trade actively by any common-sense way of looking at it. Since they are typically classified as level 3 assets, these securities are actually marked-to-model when there are no market prices. That being said, the problem is too much of a reliance of mark-to-model, not mark-to-market. They couldn't properly value these instruments (ignoring times of declining home prices) and overestimated the fair value of the securities. Mark-to-market was what kept them honest when the securities lost value. I agree with the story that the increase in value due to the securities allowed them to increase their capital base and lend an larger absolute value, but I disagree that mark-to-market was a cause of that.