Throughout this banking crisis I've been hearing financial pundits use the term - "market to market" accounting. I figured that it attempted to help financial institutions or businesses understand what their true market value was on paper. However until today, I never really dove into what the actual definition is really.
So here it is;
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.
So basically, if you buy 1000 shares of GE, and you purchase them at $22.00 and the stock goes up to $30.00 a share, then your 1000 shares are valued at $30,000. If on the other hand you buy at $22.00 and the stock falls to $10.00, then they are worth $10,000. Easy enough to understand, but the devil is in the details.
Now in the stock market you have options, futures, short positions, long positions, margin calls, etc. You also have computer traders who bet on options throughout the day, they'll pour millions into positions that they are in and out the same day. This of course can exacerbate margin calls or short calls when a stock is being pushed downward, example recently has been Merril Lynch and Lehman brothers. The problem is that these values are only determined at the end of the day, and often financial institutions are forced to buttress their stocks position during the trading day, often forcing these companies or investors to cover huge margin positions. It's a wonder that this whole system hasn't already collapsed with hedge funds, derivatives, and the myriad other Wall Street investment strategies or rules.
The problem is that there is a special accounting rule called, FAS 157, and it requires banks to assign fair value or a "market-to-market" value to these mortgage backed assets. The problem is that to have value they need to be trading, and if they are not trading then a fair market value cannot be attached to the asset. For example, Lehman brothers has 100 Billion dollars in packaged mortgage backed debt that they are servicing. 7% of the debt is in foreclosure or default, but Lehman is not the only institution with this problem. Banks across the country are having similar problems with their mortgage loans as well. At this point their is a perception that mortgage backed securities are dangerous. This has a vicious circle effect with all the players in the market and soon no one is purchasing any debt from anyone else. Despite the fact that 93% of the mortgage debt is performing!! Meanwhile, the market value of these companies cannot be determined, and then traders begin bidding down the value of these companies, which forces the companies to dilute their stock further by raising more capital.
Interesting article I read today though suggests that "market-to-market" may have in fact saved our bacon. Read this article called, "New Life".
Basically he's suggesting that this actually could work out for us in the long run. Instead of a long drawn out decline, this may have pushed us to basement allot faster, which will allow us to recover allot faster as well. We can only hope he's correct.
Look, if you still don't understand "market-to-market value" then don't feel bad. Allot of people don't understand how 93% of borrowers can be performing on this mortgage payments, but the bank is taking a beating in the market. Something just doesn't seem right, but perhaps the problem is much bigger, and market-to-market is like a forest fire that is quickly burning up the dead wood.
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