Mark to Market - why is it a bad thing?
 

There was a piece on NPR this AM about how the Mark to Market rule is being being blamed by some for the current economic mess.

I don't see it this way; without the MTM rule, it seems companies could value a truckload of turd pies at $1M/lb and nobody outside the company would be the wiser. The person NPR had on defending the rule basically said it was a pain in the ass as the value of a company's assets/liabilities would unnecessarily fluctuate as the market rose and fell. Hell, that's exactly what I would want to see!

If someone wants me to loan them money and use their Yugo as collateral, I'd expect to use the current market valuation ($3.50), not their own pie-in-the-sky assessment that it's a "collectors car" worth $500k @ BJ.

So now, the powers that be are contemplating suspending the rule. Translation: CDSs and MBSs which currently aren't worth the electrons they're printed on will have a book value of trillions.

To me it seems like an attempt to sweep some stuff under the rug.

A+

100%

Perfect!

5 Stars!

You understand exactly what is going on.

The call to change the accounting rules away from "mark to market" is nothing more than an attempt to hide the fact that certain companies are bankrupt.

I think this is a very nuanced point of discussion. The rule change that is being talked about does not eliminate the requirement to mark to market but deals with the timing.

The old rule required that assets be valued at the average of the last three months valuation. This mitigated day to day volatility but did show the trend in valuation.

The new rule required a today, or a minuet to minute mark to market. This rule change transferred the market volatility into the asset valuation meaning wild swings thru out the day. Combined with the elimination of the up tick rule for shorts and what we have seen is dramatically increased volatility.

The point is that with the current rules in effect no one can know the true value of a portfolio with any certainty. By the time a valuation is established it most likely has changed. Therefore it is always wrong.

I think all would agree that mark to market is necessary and a good practice, the debate is more related to the value of a mark to market that reflects the volatility we are seeing today or one that is more stable and smoothes out some of the volatility.

This is more a discussion about the current market volatility rather than the need for "mark to market"

This is all fuzzy to me, but MTM means that if you have a 'thing' that currently does not have a buyer... then it has no value. However, some of these 'things' still produce income and if held to maturity may still be paid back... so it has some value, no?

i.e. my software business has no (or little) value to anyone else since its essentially me and a couple of 1099's as contractors to several clients . However, it produces income for me... so it has a value of some sort, no? (not sure if that analogy is a good one).

I worked for a department store chain for many years. We had some stores that were not so great. Under these rules, we had to take an impairment charge against the value of these stores (to the tune of $10 million).

This was devastating to our stock as our earnings dropped significantly in one year. After that, our earnings were artificially inflated because these same stores no longer had any depreciation.

I feel like the only thing this accomplished was the accounting firm made an extra $100k per year because all of our properties, that had poorer than average sales, had to be valuated each year (funny, I did the pro-formas on these stores and never once was one of my values changed by our CPA). This rule only added administrative work and costs to the company.

As far as valuing a store for the purpose of a sale....no potential buyer would ever use the book value of this type of asset anyway so what was the point?

My $0.02 cents

I believe the official name for MTM accounting rules is "Fair Value" accounting. In the case of a 'thing' that has no buyer, but generates cash flow where the timing and amounts are reasonably assured, then it does have a value (and can be quantified using a discounted present value method).

I think that the problem with the CDOs and other mortgage backed derivatives is that there was so much uncertainty surrounding the timing or amount of cash flows that it was not possible to value them in this manner, so firms had to look to the secondary market = 0.

Agree that extreme care must be taken in messing with Fair value accounting rules as they should result in more transparency. A slackening of rules certainly could allow some of the mess to be "swept under the rug."

I liked MTM productions. Meow.

IMHO they should never have abandoned historical cost. The change accelerated volatility - and the old approach worked for most of the 20th century.

Didn't Enron have hundreds of unvalued assets off the books?

IMO, this is the root of the problem. The originators and sellers of this trash made awful performance assumptions. Holders now want nothing to do with the junk. You could change the rule so the septic tank is only opened once per year for valuation, but it still doesn't change the fact it's gonna stink.

The unfortunate side effect is MTM is taking down good companies. Another unfortunate downside is MTM does nothing for market strength/transparency if all players have been made into fools.

I'd say ditch the rule and let buyer beware. If you're dumb enough to think manna falls from the sky endlessly, well, shiot happens.

Think about this way. Suppose that I put 5% down a house and finance the rest. I plan on staying in the house, and I have never missed a mortgage payment in three years, so I'm a pretty good risk. Now, suppose that I bought at the top of the housing bubble, and now my house is worth 20% less than I bought it for, but I only own 10%, so I'm underwater.

If the bank had to "mark to market" my house, it would show as a loss, even though I'm making my payments and will probably be in the house long enough not to be underwater. The bank can now not lend money to anyone else, because they've "lost" some of their money on my house and perhaps a lot of others like me. If a bank has enough of these type of loans, they will have "lost" enough money to go out of business, even though they are holding assets that paying off.

In a less regulated business, mark to market makes sense, but in banking, where you have to have a certain asset to debt ratio, mark to market can ruin a bank even though their assets are pretty stable.

No, that is not what mark-to-market is about.

Mark-to-market would be you figuring your net worth and recognizing, at that point in time, you were underwater on your mortgage. (The "market price" on your house was lower than what you owed on it.)

"Mark-to-model" (which is what certain people in the financial industry want to return to) would be for you to not recognize the current market value of your house when figuring your current net worth. Instead, you would "make up" a value for your house (probably based upon some expectation about its possible future market value) and "pretend" that you were not currently underwater on your mortgage.

"Mark-to-model" is all about ignoring "unpleasant" realities.

"Mark-to-market" for the bank would involve the banks having to value their loans -- including those where the collateral is worth less than the outstanding loan -- at "market determined" values, not some "model" they make up.