Mark-to-Market Accounting: What's the Big Deal?
Posted by: Carleton Sheets in Value, Securities, Real Estate, Property, mortgage, Market Value, Mark to Market, Comps, Comparables, Comparable value, Asset on Mar 19, 2009.
Have you read or heard about mark-to-market accounting in the news lately? Mark-to-market accounting is an accounting theory of pricing assets based on their fair market value that larger banks use in reporting their shareholder equity. So how does this tie into the real estate market?
When you are analyzing a property to purchase, you need to get a sense of its current value. You do this by looking at comparable sales in the neighborhood-the price that similar homes have been selling for. This method is pretty sound, and in many cases it works just fine.
But what if you can't determine an accurate price range using comparable sales? For example, perhaps there were a number of short sales in the area or distressed properties that sold at low prices---which will drag down the comparables for the entire neighborhood.
And to make things even more complicated, what if you were trying to find a fair market value for one of the hundreds of properties whose mortgages were bundled as securities? Sometimes as many as 60% of these bundled properties can't be accurately valued.
And this is exactly what the banks are struggling with---how to put a value on these bundled assets. Many times, they can't. And if they can, the defaulting mortgages in the bundle of securities are dragging down the value of the entire portfolio.
So banks must scramble to raise the regulatory capital requirements while attempting to sell off assets that they are unable to value---which drives the asset prices down even further. And this problem is amplified in our current financial crisis situation because of slow sales and fire-sale prices in the real estate market.
By adjusting the way banks account for these bundled assets, their balance sheets may reflect asset values more accurately. And large banks could go from an "at risk" status to a "stable" status ... and possibly provide more stability in the stock market and housing market that will, in turn, give investors more confidence to invest and spend more. Or it could go the other way and create more fear and instability.
Mark-to-market accounting is a complicated concept, and my simplified example does not take its complexities into account. If you're unfamiliar with this concept, I suggest you read an article from the Motley Fool and an article from Forbes that explains the principles behind mark-to-market accounting.
Revising the way banks report on and measure asset values---perhaps by identifying those comparables that were short sales or distressed properties, etc., will not erase the lending mistakes of the past, but they may help lay the groundwork for future price stabilization. Only time will tell.
So what is happening in your market? Are you finding properties with fire-sale prices?
