Howard County Maryland Blog

Local Politics and Current Events

Mark to Market

Posted by David Keelan on Saturday, March 14, 2009

This financial rule applies to the value of a companies financial assets.

A simple analogy would be the value of the home.  If one purchased a $300,000 home and financed it through a mortgage and the value of the home is now only $150,000 when accessing one’s net worth one would not have to calculate one’s networth $150,000 lower.  The new mark to market value of the home is now $150,000 and not $300,000.

Take this concept and apply it to the financial assets of a major bank line Bank of America.  The effect of Mark to Market rules has forced them to write down millions of dollars of assets because according to Mark to Market rules those assets are not worth as much as they used to be worth.  Take all of the Bank of America’s in the US and one can see that this is a huge issue.

When banks and other institutions don’t even know how to value these assets the problem gets more complicated.  Now what if the institution never intends to sell those assets they still must write the value of those assets downward.  Is that fair?  If my house was worth $300,000 when I purchased it and is now worth $150,000 do I care?  If I want to sell it tomorrow I care but if I am staying there for 20 years do I really care?

Because of mark to market many institutions won’t sell any assets because they have written their value down and will end up loosing money.   Again the other issue is that they have to write down the value of billions of dollars of assets based on mark to market therefore driving down their balance sheets.

Congress is intervening.  A slippery slope if you ask me.  This is not a political issue and when congress makes it political then they risk undermining confidence (further) in our financial systems.  How can we foster a predictable and stable business environment if congress is willing to interfere in accounting standards for political purposes.  “Well this isn’t working out so lets just change the rules”.  Smoke and mirrors.

From the Financial Times

Congress warns on mark-to-market rule

By Tom Braithwaite and Sarah O’Connor in Washington

Published: March 12 2009 19:57 | Last updated: March 13 2009 00:32

“There are some versions of those proposals that would have that risk.”

“My personal point of view is that we have to be very careful not to do things that would erode confidence in the people’s ability to assess the risks in exposure to a bank,” he said.

Congress will force regulators to relax the much-criticised mark-to-market accounting rule if they fail to take action themselves, Barney Frank, the chairman of the House financial services committee, on Thursday warned.

Mr Frank told representatives of the Financial Accounting Standards Board and the Securities and Exchange Commission that they had to act quickly to revise the rule. “We do have to have you move now,” said Mr Frank. “You are the FASB. In this one you can’t be the slow-B.”

Mark-to-market, which compels banks to value assets at current market prices, is blamed by some for exacerbating the financial crisis because the illiquid market for certain instruments such as mortgage-backed securities has forced financial institutions to write down the value of their holdings.

“It fails to reflect the economic reality,” said Paul Kanjorski, Democratic head of the House financial services capital markets sub-committee. “If the regulators do not act now to improve the standards, then the Congress will have no other option than to act itself.”

Under tough questioning from Mr Frank’s committee, the SEC and FASB agreed to produce new guidance on the subject within three weeks.

However, Robert Herz, FASB chairman, said institutions could already apply a cashflow value to certain hard-to-value assets rather than using the last transaction as a benchmark.

David Larsen, an accountant at Duff & Phelps, said guidance from the FASB was needed to encourage banks and their auditors to “get away from that bias [towards the last transaction]” as well as providing new guidelines on the way mortgage-backed securities were treated.

Jamie Dimon, chief executive of JPMorgan Chase, said on Wednesday that although he “liked” the mark-to-market accounting rule, it had its limits. “We have taken it to a ridiculous point,” he told a Chamber of Commerce conference in Washington. “I think it’s wrong to create all that volatility.”

But Chris Dodd, Democratic chairman of the influential Senate banking committee, told the conference that Congress should resist calls to intervene in the accounting system to alter the mark-to-market rule, which should be left to accounting bodies.

“To get the Congress to decide that issue is very very dangerous … It will come back to bite you in ways you can’t imagine,” he said.

Tim Geithner, Treasury secretary, said in a hearing with the Senate budget committee on Thursday that he had reservations about suspending the mark-to-market rule.

6 Responses to “Mark to Market”

  1. Freemarket said

    Mark to market is interesting, because it does not change the underlying economics at all. It is strictly presentation. If the market is reasonably efficient and good information is available to everyone, this should not impact stock prices/business environment at all.

  2. One would like to think so, however that has not been the case. The effect has been like a margin call. Many of this financial transactions have been packaged into derivatives that the financial instution borrowed money against based upon their mark to market value at the time. The new valuations placed them at a value lower than the lender and borrower agreed to thus the borrower had to come up with more cash to cover the paper mark to market loss. It didn’t matter that these derivatives were still cash flow positive (cash machines).

    This “margin call” forced the financial institutions to dig into their reserves (thus no money left to lend to others). Some had to go to market to borrow more money – who would lend to them?

    Do these assets have value? Of course they do? Should they be valued at their current market price or their cash flow value? Keep in mind not all of these assets are full of “foreclosed” mortgages and are still generating plenty of positive cash flow.

    Now what happens when the values start going back up? These institutions had to come up with a lot of cash to cover the “margin”. What happens now?

  3. Freemarket said

    What you are saying just does not make sense to me. Was the margin call necessary because of a real decline in the value of the underlying assets, or was it necessary because of an accounting presentation change in how those assets were valued? It has to be the former. Show me an example of an asset that is trading far above or below its discounted expected future cash flows, and I’ll show you a profit opportunity.

  4. It may not make sense but that is what is happening.

    It is the former and their is a lot of profit opportunity but Mark to Market is skewing those values.

  5. rmmcqueeney said

    Basically, most if not all derivatives entered into have a fair value of zero. Most derivatives have a liquid market in which they are valued and traded. However, there are times where the markets dry up, such as the Credit Default Swap market.

    If the value of the derivative moves in your favor, the counterparty with which you transacted would post collateral with you. The opposite is true if the value moves out of your favor. Additionally, if the bank elected the “Fair Value Option” of accounting, the bank can mark its debts (short-term and long-term) to market values too. In other words, if the banks debt is under a ratings watch or their credit default swaps would show the credit ratings are lower than published by the rating agencies, the bank will write down its debt thus creating a gain on the income statement. This does not mean the bank is responsible for less than orginally incurred, it just means the chances the full value of the debt will be collected is lower. And when the debt is paid in full, a subsequent loss will be recognized.

    With banks, as their assets lose value, the losses the must take now affects the capitalization of the banks. Becuase they are regulated by the Federal Reserve, each bank must keep a certain amount of equity capital on their balance sheets. Once their capital declines below regulated amounts, they must raise fresh capital in order to maintain operations.

    The problems Wall Street is having is trying to value assets for which there an illiquid market. They must go to brokers and get quotes or use internally developed models to value these assets. Suppose you have a derivative that matures in 30 days. The chances are these derivatives have a liquid market and are easily tradable. Suppose you have a derivative that matures in 5 years. There is not an active or liquid market in which to trade these derivatives due to the length of the term.

    However, if the assets were gaining value, the world would think the mark-to-market rules were the greatest thing since sliced bread. The purpose of the mark-to-market accounting rules is to show the value of the assets today from a balance sheet perspective. There are many nuances to the mark-to-market accounting rules that cause some unlikely accounting answers.

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