Definition of mark to mark as found in Wikipedia
In accounting and finance, mark to market is the act of assigning a value to a position held in a financial instrument based on the current market price for the instrument or similar instruments. For example, the final value of a futures contract that expires in 9 months will not be known until it expires. If it is marked to market, for accounting purposes it is assigned the value that it would fetch in the open market currently.
Mark to market is a provision in Sarbanes-Oxley that is getting more and more attention as we deal with the current credit crisis. Back in 2002 several companies you might recognize like Enron, Tyco and World Comm were caught up in scandals over misrepresentation of their financial statements. The resulting legislation to “fix” the problems these bad apples caused is now sucking the “air” out of the credit markets.
Mark to market on the surface is a good business practice. Eight percent of the time, mark to market is the fair value of an asset, however we are currently experiencing part of the 20%.
Here are four instances when mark to market is not good business practice.
Lack of liquidity in the market
Assets that would not normally be considered liquid have to be liquidated
The instrument being used to value the asset is not of the same type as the asset
Markets have diverged from the physical (no convergence)
- Lack of liquidity in the market is not providing a fair value for the asset
- Assets that would not normally be considered liquid have to be liquidated
- The instrument being used to value the asset is not of the same type as the asset
- The market being used for valuation has diverged from the physical market
Chairman Bernanke over the last several weeks has warned against lifting the mark to market requirements saying, “Doing this would only hurt investor confidence because nobody knows what the true hold-to-maturity price is.”
Bernanke then commented that the sales to the government would give banks a value for these assets at amounts higher than the fire-sale prices they currently face.
In effect he is admitting here that the market is illiquid, and not paying the fair value.
For most involved in agricultural businesses the effects of mark to market have been felt in many ways this year. Suppliers are requiring prepayment, buyers are not willing to buy in forward positions, and credit has been tighter. These three areas of stress on our businesses are getting ratcheted up another notch and we need to be ready for it.
