Mark to Market Accounting

or Register to post new content in the forum

11 RepliesJump to last post

 

Comments

  • Allowed HTML tags: <em> <strong> <blockquote> <br> <p>

Plain text

  • No HTML tags allowed.
  • Web page addresses and e-mail addresses turn into links automatically.
  • Lines and paragraphs break automatically.
Oct 15, 2008 11:21 pm

What is it and how would it help if they suspended this rule?

Oct 15, 2008 11:37 pm

Companies must state the value of certain assets at certain periods of time.  If you hold a dollar that will mature at a dollar in 5 years and it is now worth .50 cents, with mark to market accounting, you have to report that it is now worth .50 cents.  Without mark to market accounting, you don't have to report it at .50 cents.  You can hold the asset until it comes due knowing it will be worth a dollar.  (Bad example, I know).

 
Some say suspending this rule will help, some say it won't.  There has to be a reason why it hasn't been reinstated since pretty much everyone knows about it at this point. 
Oct 16, 2008 12:03 am

So not only does it make balance sheets look weaker, it is also an additional loss on the income statement.

Oct 16, 2008 2:51 pm

This might help to simplify it for you:

 
Imagine you bought a house for 300,000.  That's the market value.  Imagine you have a 240,000 mortgage on it (the bank required 20% equity based on your credit).
 
Let's say, through a major market disruption, the value of your house went down to 200,000.  If banks or "retail" lenders used mark-to-market accounting in the mortgage world, you would have to cough up $80,000 and give it to the bank to get back to 80% equity (200,000 x 80% = 160,000 new loan value - 240,000 existing loan).
 
Same concept applies in the banking world.  If the value of an investment on an investment banks books goes from 1,000,000 to 500,000, you must record an EXPENSE (debit) on your income statement of 500,000, and a corresponding reduction in ASSETS (credit) on your balance sheet.  You have just reduced EQUITY in your business by 500,000.  Since there are NET CAPITAL requirements in the banking industry, when your equity drops below a certain level, you must RAISE EQUITY.  Depending on how low it goes, you may also see your credit rating drop, thus increasing your borrowing costs.
 
Why does a simple accounting concept affect the value of a business so dramatically?  Because our financial bedrock the past 20 years has been credit.  Investment firms operate on leverage.  When that leverage goes away, so goes the market. 
 
Fortunately, this mark-to-market accounting system does not exist in most industries.  Otherwise, companies would have to record expenses everytime the value of their assets went down (when I worked in real estate finance, I saw the value of many properties drop precipitously - fortunately, that only hurt is if/when we had to refinance
 
PM me if you have other specific questions on the subject.
Oct 16, 2008 2:56 pm
B24:

This might help to simplify it for you:

 
Imagine you bought a house for 300,000.  That's the market value.  Imagine you have a 240,000 mortgage on it (the bank required 20% equity based on your credit).
 
Let's say, through a major market disruption, the value of your house went down to 200,000.  If banks or "retail" lenders used mark-to-market accounting in the mortgage world, you would have to cough up $80,000 and give it to the bank to get back to 80% equity (200,000 x 80% = 160,000 new loan value - 240,000 existing loan).
 
Same concept applies in the banking world.  If the value of an investment on an investment banks books goes from 1,000,000 to 500,000, you must record an EXPENSE (debit) on your income statement of 500,000, and a corresponding reduction in ASSETS (credit) on your balance sheet.  You have just reduced EQUITY in your business by 500,000.  Since there are NET CAPITAL requirements in the banking industry, when your equity drops below a certain level, you must RAISE EQUITY.  Depending on how low it goes, you may also see your credit rating drop, thus increasing your borrowing costs.
 
Why does a simple accounting concept affect the value of a business so dramatically?  Because our financial bedrock the past 20 years has been credit.  Investment firms operate on leverage.  When that leverage goes away, so goes the market. 
 
Fortunately, this mark-to-market accounting system does not exist in most industries.  Otherwise, companies would have to record expenses everytime the value of their assets went down (when I worked in real estate finance, I saw the value of many properties drop precipitously - fortunately, that only hurt is if/when we had to refinance
 
PM me if you have other specific questions on the subject.
 
Well put.
Oct 16, 2008 4:07 pm

Well put guys. No , I won't even go to the subject of Zero Based Budgeting and why Governments will not move to this more efficient method for budgeting. For accounting types you all know fully why they resist.

Oct 16, 2008 8:23 pm

What if I buy Apple on margin at 200 and my broker gives me a margin call at 100. Can I tell him, 'Look, I'm going to be holding this for 10 years, when the stock will surely be selling for 500, so lay off me!'


Oct 16, 2008 10:08 pm
norway401:

Well put guys. No , I won't even go to the subject of Zero Based Budgeting and why Governments will not move to this more efficient method for budgeting. For accounting types you all know fully why they resist.





Yeah, it's much easier to "build" an increase on a bullshit budget to begin with than to start from scratch and REALLY see all the hidden BS in there. In my last profession, it was strictly zero-based budgeting (except for the top line, of course ) . Somehow, I could always justify telling the team they had to increase revenues 5% and expenses 2.5%. It NEVER actually worked, but it gives them something to shoot for!

Oct 17, 2008 10:43 am

Mark to market is killing the muni funds, especially the high-yield munis.  I listened to an Oppenheimer Rochester call the other day. They basically said that if they hold the same muni bond as a company or hedge fund out there, and the hedge fund dumps it at some ridiculous rate just to raise cash, Oppenheimer's pricing system HAS to mark down that price to calculate NAV.  So, even though nothing has changed with the municipality or the interest payments, just because the same bond was dumped by someone, and that was the only sell recently in that bond, THAT becomes the new value of the bond. 

 
So, the moral of the story is, if you have five years or more, you may want to pour some money into the high-yield muni funds. As those bonds mature, and pay out at par, those NAVs will go up dramatically.
Oct 17, 2008 11:01 am

B24...funny how Zero Base Budgeting really shows THE FACTS. Have been through the same debates as you have in your past.

Oct 17, 2008 3:52 pm

Those two dreaded words.....BUDGET....SEASON.  Towards the end, it seemd like "budget season" was half the year.  The other half was "AUDIT SEASON".