"Mark to Market" was introduced to keep firms from postponing their day of reckoning, which allowed them to deny insolvency until they were also illiquid. But, mark to market assumes a rationally functioning market, so it may be too strict for now, but it is better than the alternative.
Level 3 assets are a disaster. The idea was to allow management to value (and accounting firms to review) the occasional difficult to value asset, but it became a dumping ground to hide losses. I think the right path for now is temnporary forbearance, with the goal a return to full mark to market, and some sort of future restraint on allowable Level 3 assets--such as a mandatory high-percentage charge against capital.
Full fair value should be a disclosure for most financial institutions for these instruments - and should not be recorded through capital and income. Essentially, the banks have been told to mark their long-term assets, for accounting purposes, like a big trading book-which is essentially at liquidation value. Further, the FASB and the SEC have declined to call even the worst of these markets distressed, which in and of itself even under the existing accounting guidance would provide relief from relying on fire sale prices to mark them. This is doubly dangerous, because it works both ways (exaggerates booms and busts).