Mark to market means that financial assets are marked up or down based on the their price on a given date. For example, brokerage houses routinely do this when they issue your monthly statements. Let's say you buy 100 shares of a $10.00 stock and it drops to $5.00. Your brokerage statement will show your net asset value on this security as $500.00.
Now we come to banks. And here is the tricky part. There is an SEC rule that says that banks must use the mark-to-market procedure to price their assets. There is also a clause that says that they SEC can suspend the rule if it so chooses. This process of mark to market is now creating a major dilemma for most banks. As an example: the Federal Home Loan Bank of Atlanta had three securities showing an $87.3 million loss and had to take that write down. This is a toxic asset that nobody wants. The few investors who would purchase it are throwing in "fire sale" bids in the hope of buying it "on the cheap." The prices of these assets are so wild that there is often a 2000 to 3000 basis point between bid and ask.
The bottom line is that banks are reluctant to sell the assets for virtually nothing and are leaving them on their books. This creates an extremely dangerous situation for two reasons: 1.) taking the loss at mark to market wipes a large chunk of bank equity and hence their lending power, and 2.) there is no way to determine the true value of the bank's stock price.
The SEC is meeting in early January to review this matter and it will be interesting to see what they come up with.
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Reader Comments (Page 1 of 1)
12-21-2008 @ 9:49PM
edneestoknow said...
I understand the concept of mark to market, but the issue is establishing the market value. The original Fed plan was to buy the toxic assets, and their problem seemed to be that their value could not be determined. In other words, the market value could not be established. If the value cannot be established, then what do the banks "mark" to? I can't believe that the banking industry would intentionally establish an arbitrary low market value and thus reduce their assets. Someone, somewhere has to explain how they determined market value, and why nobody seems to have any confidence in that number. I would love to have a day or two of meetings with one bank holding such losses. I would at least leave with an understanding of the method that I could explain in articles such as the above, and more likely find and point out how little they know about their own business. The size of an organiztion seems to be indirectly proportional to their ability to address huge problems. I have dozens of questions I'd ask in such a meeting, and I've only given it 10 minutes of thought.
I'll bet a lot of people would be working throughout the night to get answers ready for day two.
12-22-2008 @ 8:31AM
BHarrison said...
As said in the article, it is the same way that the brokerage firms use to report to stock holders, right? Why should it be ANY DIFFEREENT for the banks?
If the SEC allows the suspension of the "mark to market" then how does an investor know what the relative value of anything is . . . and that would just be another "defrauding of the American investors".
We've had enough of this corrption and rip offs to date. Suspending the "mark to market" would REVMOVE WHAT LITTLE INTEGRITY THERE MIGHT BE IN THE STOCK MARKETS. Only a fool would invest in such a market.
12-23-2008 @ 8:58AM
Peter said...
Here is the problem with Mark to Market. These securities are intended to be held to maturity. Let's say you have a bad MBS that has a 20% default rate. That means that 80% of the loans are being paid off on time and are not problems. At worst this bond should be priced at 80% of par not at the pennies on the dollar that they are now. Even with a horrid bond of 50% default that means 50% of that bond is fine and should be priced no lower than 50% of par.
Recently paper from the major banks were traded between 5 and 20 cents on the dollar which means the market is broken.
There used to be an investment category on bank balance sheets that were held to maturity. Now with mandatory mark to mark those securities are forced to be priced at whatever the market is paying for similar bonds even if there is no intention of selling them. Banks should be able to hold those bonds separate balance sheet line unless they plan to sell them in the next 12-24 months.
Bonds are vastly different than stocks and can't be treated as stocks.
BHarrison says "how does an investor know what the relative value of anything is"
However those bonds are way more valuable than the market is currently saying they are. Mark to market only works if there is an active, orderly market as there is in stocks. Why do you think PIMCO is buying up MBS by the truck loads.
12-22-2008 @ 1:16PM
Iridium said...
See someday because of inflation my house will be worth $7 billion.
I should be able to take out a home equity loan for almost $7 billion.
Although that is a little bit of a stretch that is the way bank actually did thier books.
An asset is worth what it is worth if you sold it today. It isn't worth what it was in the past or what it may be in the future.
Mark to market rules just force banks and other institutions to show what the real value of thier holdings is.
The problem is that these rules showed how poor the state of the real economy is. The veil that covered the wizzard has been pulled.