Mark to Market

What is Mark to Market Account?

Mark to Market
accounting, or fair value accounting, mandates that companies must value their assets on their balance sheet based on the price that these assets could be sold for on the open market.  This accounting methodology was put in place to allow shareholders to understand the true value of a company through the somewhat "real-time" pricing of its assets.  It was said to bring transparency into investments and assets on the companies balance sheet by removing the option of hiding potentially large paper losses under the rug. 

This practice of marking to market is especially prevalent in futures trading where the CME (Chicago Mercantile Exchange) marks each futures contract two times a day.  Basically, the account value will either be debited with a loss or credited with a gain based on the movement of the contract.  This practice is followed to prevent traders from taking gigantic losses which can mount up quickly due to the high leverage which is used in futures trading. 

On the other hand, mark to market accounting has been blamed partly for causing one of the largest meltdowns in financial markets history.  With the recent implosion in the mortgage market, mortgage securities such as mortgage backed securities have taken a substantial hit in price due to investor panic coupled with liquidity issues in this market.  Pricing securities on the balance sheet now becomes very difficult for level 2 and 3 assets which do not really have market prices due to the fact that there are no pricing guidelines.  Some of these securities don't even trade every day and therefore must use pricing models to come to a guesstimate.  That comes to the problem at hand.  Many of the investment banks on Wall Street have Billions of dollars worth of exposure to these types of securities and many of the pricing models are suggesting that these securities are worth pennies on the dollar.  The deterioration of the financial picture due to this accounting is causing banks to seize up or seeking capital infusions.  This is causing panic around the health of these banks and you have a perfect storm of self-fullfilling implications. 

Now, enter derivatives.  Credit default swaps and Credit default obligations are basically insurance products which guarantee the face value of the mortgage backed security and other financial instruments for a fee.  The market for these derivatives is not understood as there is no common exchange where these products change hands.  There is no transparency here but it is said to be nearly a 100 Trillion dollar market of outstanding guarantees which may or may not be capable of being fullfilled.

In general, mark to market accounting sounds good in theory but does not seem to work as well in a crisis where fear and liquidity concerns run rampant through a market. 
Tim Ord
Ord Oracle

Tim Ord is a technical analyst and expert in the theories of chart analysis using price, volume, and a host of proprietary indicators as a guide...
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