The crucial paragraph is here:
"Under SFAS 157, it is appropriate for you to consider actual market prices, or observable inputs, even when the market is less liquid than historical market volumes, unless those prices are the result of a forced liquidation or distress sale. Only when actual market prices, or relevant observable inputs, are not available is it appropriate for you to use unobservable inputs which reflect your assumptions of what market participants would use in pricing the asset or liability."

"It's an invitation to fudge!" says Floyd Norris in the New York Times -

Some people on Wall Street think that nearly every sale today is a forced sale. There are entire categories of collateralized debt obligations where most, if not all, of the trades, occur because a holder has received, or expects, a margin call. What the S.E.C. should require is a disclosure when a company concludes that a market price should be ignored because it came from a “forced liquidation or distress sale.” Then there should be a disclosure of how much lower that distress price was from the value the company is using in its own valuation.

And Yves Smith gets acerbic:

Funny how no one had a problem with mark-to-market when asset prices were rising. The process in reverse leads to mark-to-market gains, higher net worths fueling balance sheet growth and credit expansion, which led to more demand for financial assets. That gives you higher securities prices which least to more mark-to-market gains. Sounds like a bubble, doesn't it? The SEC's solution for the contractionary version of this dynamic is simple: ignore those market prices if they are too ugly.

Couple of points. First of all, this isn't a rule change; the Fed is just reminding banks that, if they happened to have a lot of devalued assets around, then there is this loophole that they might consider using.

Second, the rule itself is inherently a bad idea. Think about it. What's the point of mark to market accounting? What, in fact, is the point of publishing accounts at all? It's to give investors (and others with exposure to the company - its suppliers, its customers, its creditors, and even its employees) some idea of the company's financial strength. Mark to market accounting is, in a sense, asking "OK, if everything went pear-shaped for your company right now, how much money could you raise by selling off your assets, in order to keep the lights on and the coffee machines running until things improved?" And that's obviously determined by the market price of the assets.

Now, a lot of companies would argue - hang on, it's not fair to mark our portfolio to market, for two reasons.
First, we're holding a lot of assets that trade in a small and illiquid market, so the price is volatile; that means that our valuations will go up and down and that will unsettle our investors unduly.
But this isn't a good argument for abandoning it; if you have to liquidate those assets, then that's the market you'll be in. In fact, if you're a big player, the mere fact of you liquidating them will drive the market down, so even strict mark to market is overestimating your assets vis-a-vis what they would actually get if you sold them. And if that worries your investors, well, you'll just have to educate them about why your strategy of investing in volatile, illiquid assets really makes sense despite the numbers, and then they'll stop worrying. And if, however much you educate them, they still don't believe you - well, they're probably right to be worried about your strategy, and you should consider changing it.

Second, we're holding assets that trade in a market which has recently seen a lot of forced sales, so the market prices don't represent their true value.
And this is an even worse argument. If you're in a market dominated by lots of the sort of people who have recently had to make forced sales, then there is a good chance that you, too, are one of those people. And so it's even more important for you to mark to market, because "having to sell off lots of assets in a hurry to keep the lights on" is no longer a theoretical possibility for you - it's quite possibly your next move.