Mark-To-Market Accounting

What’s Mark-To-Market?

Since the recent economic turmoil began, there has been a lot of talk and discussion about mark-to-market accounting.  If you’re like most people, you have no idea what this esoteric term means.  Simply put, mark-to-market accounting is an accounting method that assigns a value (or “mark”) to an asset based on it’s current market price or the market price of a similar asset.  

One example of MTM that you may be familiar with is mutual fund pricing. The price of a mutual fund share is known as the NAV or Net Asset Value.  Everyday when the market closes mutual funds calculate their NAV based on the closing prices of all the fund’s stock holdings. This is usually an easy process since stocks trade in highly liquid markets and always have a price.

Mark-To-Market’s Problem

The problem with MTM is when the assets being valued don’t trade in a liquid market.  If I asked you to mark shares of Apple (AAPL) stock you own, you would just look up Apple’s current share price and tell me, “$88.93″.  But what if you owned a major stake in a maple syrup conglomerate?  Maple syrup companies don’t get bought and sold on a regular basis, so it’s much more difficult to come up with a market value.  

The same can be said about Mortgage Backed Securities (MBS’s) and other complex assets that trade infrequently due to the financial crisis.  Many of these securities don’t even trade once a day.  When they do happen to trade, it happens at a depressed value due to a lack of demand.  As a result, banks are having to write down the assets on their books to reflect these prices.  

Some in the financial community are calling mark-to-market accounting unfair since many of these impaired securities are still making their interest payments on time.  They say the current depressed market prices are unreasonably low, and that banks should be able to value these securities by estimating their future cash flows.

As for my opinion, MTM certainly isn’t perfect.  However, it may our best bet when it comes to keeping a standardized and transparent accounting system.  Remember, this rule was created to help prevent companies from overvaluing the assets on their books (ie; Enron).  If these assets were truly as depressed and undervalued as some say they are, I’m sure the smart money would have jumped on the opportunity to buy them.  Remember things are only worth whatever someone else is willing to pay for them… whether it’s houses, cars, stocks or mortgage-backed securities.

What are your thoughts and opinions on MTM?