Marking to market
What is it?
Marking to market is the term used to describe the process of adjusting the value of an asset to reflect the price you'd get for it if you sold it right now.
For example, you might have bought your house for $200k two years ago, but if house prices have fallen 25% since that time, marking your house to market would give you a price of $150k.
Marking to market is also known as 'fair value accounting'. It is to be distinguished from 'mark to model' (working out the price of something according to a mathematical model) and 'mark to maturity' (the price of a product if you keep hold of it until its sell-by date).
What's it got to do with the financial crisis?
Marking to market is at the heart of the credit crunch. The American Financial Accounting Standards Board has pushed hard for mark to market accounting, and in November 2007 it passed FAS 157, requiring that American banks at least price the assets held on their books according to their current market value.
In the opinion of some people, the crunch would not have happened, or would at least not have been nearly so bad, if marking assets like mortgage backed securities and CDOs to market wasn't necessary.
Without mark to market, banks could, for example, simply hold any illiquid assets which no one wanted to buy on their books at the prices they'd bought them for, and claim that the fall in their price on the open market wasn't relevant because they had absolutely no intention of selling them.
(Barclays Capital has, for example, used precisely this argument with regard to some of the leveraged loans it was holding (Financial Times).
As it was, however, banks had to keep calculating the value of illiquid assets like mortgage backed securities according to their current market value. And when their current market value fell, they had to make big writedowns. The problem was therefore made worse when desperate banks offloaded their hard-to-sell assets at bargain basement prices - all other banks were then forced to mark to market at the new low price.
On 1 October 2008, the US regulator, the Securities and Exchange Commission (SEC), decided that mark to market was actually making the credit crunch worse. As a result, it agreed to allow banks to ignore prices achieved during 'distressed sales' and companies to mark to maturity if they intended to hold toxic assets long term.
In doing this, the SEC hoped to reduce the need for future writedowns, reduce the need for banks to raise capital to meet those writedowns, and encourage them to start lending again.
Europe also relaxed mark to market accounting standards in October 2008, by making it easier for companies to recategorise assets so that they could be accounted for based on their value over the asset's lifetime.
In late October 2008, Deutsche Bank managed to avoid a substantial third-quarter loss by applying the new accounting rules.
With no end to writedowns in sight, banks instead successfully lobbied lawmakers to change the accounting rules to reduce the carnage. As a result, in April 2009 the US Financial Standards Accounting Board eased accounting rules to give banks leeway to make their own decisions again on how much their assets were worth. That freed banks from the pressure to value assets at rock-bottom market prices.
The change to the accounting laws spurred an outcry, however, as critics complained that easier accounting rules would subject shareholders and management to guesswork and would allow zombie banks with toxic assets to stagger along in apparent profitability and health while hiding the dire state of their balance sheets. To repair this, FASB required banks to report their toxic assets every quarter, instead of just once a year. FASB also said it might require banks to apply the rules to other crucial assets, like loans.
Throughout the crisis, bank executives were divided on the value of mark-to-market rules. Many opposed them. In the fall of 2009, however, Goldman Sachs chief executive Lloyd Blankfein said that the installation of mark-to-market rules in the runup to the crisis would have provided ample warning of falling asset values.. That, in turn, would have prevented a sudden crash, he argued.
Last updated on 16 November 2008.
