What Is Mark To Market?

One buzzphrase going around about the financial crisis is “mark to market.” Some think banks are being overly punished by being forced to “mark to market” the investments they own, or price them according to current market value. As you can probably figure out, those assets have plummeted. Marketplace’s Paddy Hirsch explains with his trusty whiteboard and stick figures what “mark to market” means, and what it means for the economy.

Mark to market [Marketplace]

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  1. shoelace414 says:

    I believe Mark to Market rules came out of the Enron collapse.

    But maybe it was explained in the video, I’m at work.

    • Ash78 ain't got time to bleed says:

      @shoelace414: I think it’s been going on for a long time in M&A activity, since a purchasing firm needs the investment bankers to provide a true value (in that moment) of the target firm’s assets and investments in order to provide a better estimate on the purchase multiples.

      I’ve never heard it used outside of M&A or loan securitization activities. Still haven’t heard it mentioned in the media.

    • winstonthorne says:

      @shoelace414: When you use mark-to-market in good times (such as during a “bubble”) it artificially inflates the value of your holdings, making your balance sheet look hot as hell when in reality you have losses coming out of your ears (ENRON). The other edge of that particular sword (which is what’s going on in this article) is when assets are plummeting in value (say, right now) you wind up understating your holdings. This is why most accountants prefer to follow the long-held GAAP rule which states that assets must be booked at cost.

      • ADismalScience says:

        @winstonthorne:

        ENRON’s balance sheet was inflated because Andy Fastow pocketed non-performing assets in vehicles called “SPV’s.” It wasn’t that mark-to-market accounting wasn’t applied – it’s that the assets involved were willfully misrepresented as standalone level 3 vehicles to achieve better “management expectations” used to value them in the course of m2m accounting.

        Booking at cost is not practical for level 3 assets, which is why m2m is applied. The issues with misrepresentation typically center around which assumptions get to be used to value those assets, which trade infrequently and don’t have a liquid “market” upon which to base valuations.

        For example, say I dug up a new kind of metal in my mine. It seems to be a superconducting metal that cures cancer upon contact. I put this hunk of metal on my mining firm’s balance sheet. What’s it worth? I’d mark it to market using assumptions, but in reality it’s just a ballpark figure. Think in terms of assets typically sold at auction, like Honus Wagner cards.

    • Repique says:

      @shoelace414: Actually, part of the problem was that Enron was *using* mark-to-market. But in sort of the opposite way. The banks now have had to reduce the value of a lot of things because the market values are low, whereas Enron was marking a lot of things up because they claimed the values were high.

  2. Munsoned says:

    I think that when I try to refinance my mortgage, I should also be allowed to just “model” my house’s value, not give the bank a real market appraisal because the market stinks right now and I don’t like the valuation it’s giving me. I think I should be able to tell the bank that I think my house isn’t REALLY worth less than my mortgage, it’s really worth what it was when I paid for it in 2005. Hell, I’ll go one better and give them the 2007 value as a fair “average.”

    /sarcasm

    • ADismalScience says:

      @Munsoned:

      Appraisals are actually a nice analogy for m2m accounting!

      Say you own a really nice house that you had custom-built in a strange country called, I don’t know, Detroit, where very few houses have sold recently and market conditions have rapidly deteriorated. An appraiser comes by to value your home based on what, exactly? There’s almost no recent sales data and your home isn’t like many others in town – the valuation would be based on assumptions about the underlying market for your home and the intrinsic value of the property.

      That, essentially, is mark to market accounting.

  3. Blueskylaw says:

    Mark-to-market is an accounting methodology of assigning a value to a position held in a financial instrument based on the current market price for the instrument or similar instruments. For example, the final value of a futures contract that expires in 9 months will not be known until it expires. If it is marked to market, for accounting purposes it is assigned the value that it would currently fetch in the open market

    The practice of mark to market as an accounting device first developed among traders on futures exchanges in the 19th century. It was not until the 1980s that the practice spread to big banks and corporations far from the traditional exchange trading pits, and beginning in the 1990s, mark-to-market accounting began to give rise to scandals.

  4. chilled says:

    Assets marked down now,could possibly be marked back up later,assuming the world doesn’t end.

    This is a complicated problem,since banks have capital ratios that must be maintained.With bank stocks falling,its hard to raise capital.

    These are very strange times…

  5. Repique says:

    The accounting principle of conservatism aside, to me, the real question is whether there’s a reasonable possibility that these assets are really going to be worth their original book values ever again. If it’s a temporary drop in value, okay, I could see that being an unreasonable burden. Given that everybody now is shaking their heads and wondering what possessed us all to treat high-risk mortgages like low-risk securities, I find it hard to believe that the market values are going to return to what they once were, and the financial statements should reflect that.

  6. White Speed Receiver says:

    M2M is a bad thing. There are a few things out there that are worse, but not that many. The purpose of recording assets at cost are to give an accurate view of any potential gain or loss upon sale. There are obviously exceptions, but they are rare.

    M2M gives shady (read: corporate) accountants an opportunity to clean up their books in ways that could only otherwise be accomplished by fraud.

    • JustThatGuy3 says:

      @White Speed Receiver:

      Mark to market is a lot better than cost accounting. If I use cost accounting, I can carry those 1 million Citigroup shares I bought last April at $27/share at $27MM, since that’s what they cost me. Mark to market requires that I account for them at what I could actually get for them (about $3.5 million).

    • exconsumer9 says:

      @White Speed Receiver: What other price for a good is there but the market price? I know you think it will go up, but other’s don’t and aren’t buying it . . . so it’s not worth that much. Upon sale, it’s going to get sold for the market price, period. There is no other standard.

      I suppose you’ve got a legitimate issue with bonds and the like, but that’s quantifiable. “We’ve got 1 million in losses this year, but all from marking our brand new Bonds to market.” That sends a pretty clear message, a good one, to your investors. And besides, if the only thing keeping you from insolvency are slow to mature assets, you’re still sunk: you’ve got to pay your bills today, not 5 or 10 years from now. Your nearly matured bonds should offset your new bonds (or other well performing assets) if you’re being responsible. If you can’t weather the time it takes for your assets to mature you’ve made a bad investment.

      To be honest most of that is moot. The real trouble came not from assets that take a long time to mature, but assets that are unstable and toxic outright.

  7. TVarmy says:

    It’s down. That’s really odd; I thought Paddy was posting these up himself. Maybe it’s an embed error or something? Anyone else getting this problem? Is there a mirror? By my understanding, Mark to Market lets a company claim its worth whatever it says, and I was wondering why that ever came to be an accepted practice in the first place.

    Again, by my understanding, that is a total conflict of interest, and goes against the free market principle that rational economic agents get accurate information.

    • darman says:

      TVarmy: Mark to Market lets a company claim its worth whatever it says

      Technically (and loosely), under US GAAP, FAS 157, it is an exit price, so theoretically, it is what a company claims everyone else thinks it is worth.

    • JustThatGuy3 says:

      @TVarmy:

      It’s not at all “whatever it says,” but rather “whatever we could sell it for.” There’s a big difference. Clearly, there is always a degree of estimation (if I own 100 shares of GE stock, I can tell you with great precision how much I could sell them for right now – check out yahoo finance, and look at the market price). If you have a bond that’s very much like something else in the market, but not identical, you have a pretty good idea (if GE debt maturing in 2020 with a 6.0% coupon is selling for 92 cents on the dollar, then if I have GE debt maturing in 2020 with a 6.1% coupon, it’s reasonable to assume that it would sell for slightly more than 92 cents).

      Mark to market runs into trouble when there’s really no market for something, so getting that market-based benchmark is pretty tough. For example, think of a $10 set of Christmas lights on December 26th. If you sold them that day, you might only be able to get $5 for them (and using mark to market, you’d have to carry them at $5 on your balance sheet). If you’re willing to wait until next December, though, they could well be worth $10 again. Problem is, a lot of these assets could turn out to be the Christmas lights, but they could also turn out to be pork with an expiration date of yesterday.

  8. Dan Esparza says:

    I remember when we were first talking about the bailout (as a country) financial guru Dave Ramsey was suggesting that we change ‘mark to market’ as part of his ‘Common Sense fix’.

    For more information, there is a PDF on Dave’s website: [www.daveramsey.com]

    • David Brodbeck says:

      @Dan Esparza: I remember that, but I was pretty skeptical about it at the time, and I continue to be. Part of the problem in the current market is no one knows what other institutions’ assets are worth, so they won’t lend to them. Allowing institutions to further hide the bad assets on their books doesn’t seem likely to fix that.

      I could be wrong about this, because I’m not an economist. But Dave Ramsey isn’t, either. Personal finance experts often assume that they also understand macroeconomics, but it’s kind of a dangerous assumption.

  9. Pinget says:

    This is really simple. Your bargain loving aunt comes back from the flea market with a tchochke. “This is worth $100!” she says. But somehow she got it for $2.50 at the flea market just now. $100 is mark to model. $2.50 is mark to market.

  10. pschroeter says:

    A few years ago I read a book on the Enron debacle in the 90s and I remember that M2M was a way they could sort of lie about their financial condition to investors. Is anyone watching and regulating these idiots? I beginning to wonder if our economy ever does well or whether we are continually just cooking up sleight of hand accounting tricks to make it appear prosperous.

    • INsano says:

      @pschroeter:

      For your latter question, other than the tech boom (which had an unfortunate bubble because people make WAY too much money when they exaggerate things to be able to resist) Our economy hasn’t really improved or developed much in a long time.

      Look at the figures that are thrown around when people talk about our economy:
      “Jobs created”, which of course doesn’t value the *quality* of the job created.
      “Unemployment %”, which of course doesn’t account for those ineligible, which is a larger population than those eligible.

      Some real figures might include:
      *jobs outsourced
      *underemployed %
      *jobs that provide benefits
      *Relative GDP that takes into account population growth and inflation
      *statistics relative to other developed nations(infrastructure, technology, health, education)

  11. Anonymous says:

    In Jim’s example he said that 500 dollars in cash = 500,000 dollars (half a million).