Mark-to-Market Accounting is assigning a value to a financial instrument or asset, based on current market price or the fair-value of the asset. The term originated with futures trading a century ago. When taking a position, a trader, would deposit money on the margin to protect the Exchange against loss. At the end of the trading day, the trader’s contract would be marked to its current market value. The account would then be paid the profit or charged the loss. If the balance of the account fell below the deposit required to maintain the position, the trader would undergo a margin call and immediately pay an additional amount into the account to maintain the position.
Recently, Mark-to-Market accounting caught on with banks and corporations who used this accounting method for assets that were not traded day-to-day. Since no day-to-day market value was available, the asset’s value was based on rules established by the Financial Accounting Standards Board (FASB). The FASB is the designated private sector organization in the US that establishes financial accountingand reporting standards. The FASB ruled that fair-value was…”the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” Banks and corporations would determine the fair-value of assets based on financial modeling and use “mark-to-model” estimates. Sometimes the assets were marked in amanipulative way to achieve spurious valuations, e.g., Enron.
Now, congress and others place much of the blame for the subprime-mortgage crisis on the “mark-to-market” accounting rules. They argue that in a depressed economy fair-value accounting does not work. In a distressed market, banks account for their assets at unrealistic rock-bottom prices. In some cases, margin calls are triggered. To raise cash to pay off the account, fire-sales are initiated exacerbating the crisis. As a result, large financial institutions have recognized significant losses even though their assets may have positive cash flow values, or might be worth more at some point in the future, or under a different accounting method.
The argument is, if banks were allowed to relax the “mark-to-market” rules, they could show higher values for their assets, which in turn would free up reserves allowing the banks to make loans to their customers. Investors are hedging their bets that the “mark-to-market” rules will be relaxed, which would be an improvement for the economy. As a result, some have started investing again rather than holding their cash. Once banks free up money to lend, developers, contractors, brokers, real estate investors will make a great return as the economy is reenergized.
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