Mark-to-Market

Mark-to Market is an accounting rule where businesses must revalue or ‘mark’ a financial asset or liability to its current market price.

The rule began with futures traders who must maintain a margin account with their broker and adjust their margin accounts according to the current value of their futures portfolios.  However, special options that don’t trade on the open market like credit swaps or interest rate swaps do not have price information readily available and therefore have a hard time accounting for value.  Companies like Enron used this loophole to commit fraud and in 2007 all companies were required to account for financial assets and liabilities as if they were to be sold and recognize the gains/losses in that year.

The problem is that many companies in the news right now had huge portions of level 3 assets on their books.  Here’s a good definition I found,

Level 3 consists of unobservable inputs, such as those that reflect the reporting entity’s own assumptions about what market participants would use to price the asset or liability (including risk), developed using the best information available without undue cost and effort, according to FASB. There is no verification requirement if the assumptions are in line with those of market participants.

Since the housing crisis, companies have had to “Mark-to-Market” those assets and liabilities which are very hard to value.  What makes the problem so bad as to make companies like Lehman Brothers go bankrupt is that they are using those level 3 assets as leverage to raise capital.

For more about this read this article published November 7, 2007.  It has some great priditions about Lehman, Merrill, and Citigroup.

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