The Rules of the Game
by David on August 11th, 2009
All games have rules. In fact, you could say that games are their rules. Rules are arbitrary, but as long as they are applied equally and consistently to all players and teams, their arbitrariness is irrelevant.
Real economic life is supposed to be too serious to be a game. Humans have practiced commerce and trading for millennia with few, if any, rules. But as economies and the businesses within them have grown more sophisticated and complex, so have the rules used to regulate and to measure them. This is especially true of accounting rules, known as Generally Accepted Accounting Principles (GAAP).
In recent years, a major controversy has erupted about one of these rules known as “mark to market.” Assume a bank makes a $100,000 loan on January 1, 2009, that a borrower agrees to repay with interest in five years. GAAP has traditionally held that the bank’s $100,000 loan asset should be valued at $100,000 until maturity, as long as it is considered collectible. But, at any given time before maturity, the loan’s value on the market may be 102 cents on the dollar, or 97 cents on the dollar, or whatever investors are willing to pay. In that case, should GAAP still maintain the value of the loan to the bank at $100,000? Or should it be $102,000 or $97,000? In technical terms, should the loan be marked to market or not? This is important because, if the loan were marked to market based on our example, the bank would record temporary income of $2,000 or a temporary loss of $3,000.
GAAP is supposed to make the financial statements of all companies as transparent and comparable as possible. This is a worthwhile goal, but nothing in this life is free. Accounting rules, like baseball rules, are inherently arbitrary. Changing them changes how businesses operate, but there is a key difference between games and real life. After a certain amount of time or number of innings, games end. A new rule can be implemented when no games are being played, allowing everyone to start with the same clean slate. But business never stops. All changes to GAAP or similar rules are implemented while business is in progress. Businesses have no alternative but to adjust their decisions and strategies according to these new rules. There is not a clean slate. The result is that businesses, like games, start to become the rules. To ask if this is “good” or “bad” may be a virtually meaningless question. But it does make business seem a lot more like a game.
