MainStreet Explains: Mark to Market Accounting

If you’re following the financial markets these days, a common phrase you may have heard or read is “mark to market,” which may have left some scratching their head. With the volatile markets or, shall we say, stalled or stagnant markets understanding what is meant by mark to market activity is more important than ever. Expect to see the term more as congress debates a bailout plan that is a tool to “re-establish market place and start to free up the institutions to trade with each other, says Martin Evans, a Professor of Finance and Economics at Georgetown University.

MainStreet spoke with Evans to define “mark to market” and tell us why we should care.

What does Mark to Market mean?
If a company, whether it’s financial institution or a bank, buys a financial asset they have that asset on a balance sheet. But, the price on the balance sheet changes [depending on the markets]. The question is: How should that be reflected? If the price goes up, then the balance sheet should reflect that, and similarly if the price goes down, then the price should be reflected. This process of looking at how much you could sell the financial asset, i.e. stocks, bonds, or derivatives for [based on the market], is called mark to market.

Why should you care?
This is extraordinarily important because in the world’s banking industry financial institutions have stopped trading lots of the bonds that they usually trade with one another. The only circumstance when [trading or selling] is taking place is if an institution is desperate to sell. And, so the buyer knows that the institution is desperate to sell, so the financial institution buys them for a lot less then a normal market levels. That’s a problem because under the accounting rules, the prices for which those transactions are sold are reflected in the balance sheet of the financial institute if they have similar assets.