Erudite Boston Thug Explains New Banking Rules...

... with the help of the world's greatest CPA. 

"So whaddaya know?"

"You know what mark to market accounting is?"

"No."

Marty looked pleased.

"You wouldn't understand detail anyway," Marty said. "Say you kept a ledger, which in your case is unlikely, but say you did, and you're making knuckle knives.  You sell one to Hawk for a buck,and you debit your asset column one dollar, and credit your liabilities column one dollar.  The two columns are always supposed to be equal."

"I don't have a ledger," I said. 

"I know," Marty said, "and if you did, the columns would never be equal. But this is hypothetical."

"And Hawk's already got a knuckle knife."

"Shut up and listen," Marty said. "So you keep your ledger and somebody says how much money you got and you say a buck, and they say show me and you take the buck out of your pocket and wave it under their nose.

"But," he said, and paused expectantly.  "Suppose you and Hawk have a deal.  He'll buy a knife every year for five years.  So you debit a buck from the asset side, and you credit five bucks on the liability.  Because that's what the deal's worth over time."

I nodded.

"Get it?" Marty said.  "See the problem?"

"What if Hawk dies or backs out of the deal?"

He was thrilled.

"Or somebody comes by in the first year and says show me the cash?" he said.

"I take out my one dollar."

"And suppose the guy that's asking has just fixed your sink, and seeing that you have five dollars in revenue, does it for credit, and now wants his five smackers?"

"I don't think I've heard anyone say smackers since I donated my Perry Como albums."

"Never mind that.  What I described in grossly oversimplified terms is another kind of accounting called mark to market."

"Thank God for the gross oversimplification," I said.

"And here's a little embroidery," Marty said. "Say you think the cost of knuckle knives will go up over time, so you, or probably I at your behest, because you pay me a monstruous retainer every year and I am in your pocket, make a projection of how much the price will rise, and decide that they'll be worth two bucks, five years hence."

"Hence."

"Yeah, hence. I went to the fucking Wharton School, remember.  So now you've got a deal worth ten simoleons and you credit that.  But how much actual cash you got?"

"A simoleon."

"See?"

"And the advantage of that is it inflates your revenue."

"Yes."

"Which makes your stock worth more."

"Yeah, and if you need to show an even bigger profit you can just move the curve."

"Predict that knives will sell for two-fifty," I said. "And then I can show a credit of twelve-fifty."

"Exactly."

"And it's legal."

"Sure, mark to market is perfectly legal, often useful, sometimes necessary, in companies where a reasonable curve can be predicted.  But it's less, ah, appropriate for a company whose product may fluctuate wildly because of war, or climactic events, or political decisions, or economic circumstance, or the death of some Arabian sheik."

"And you might find yourself with a cash-flow problem."

"Yeah.  You have to pay your employees, for example, in cash.  If you have debt to service, and you're cash-poor, you have to service that in cash.  And you have to do it now, not five years from now."

"So," I said. "Worst case?"

"You can't pay your bills.  You go bankrupt."

(Abridged from Bad Business, a Spenser novel by Robert B. Parker)

Now don't you feel reassured about our financial institutions?