Mark-to-Market (MTM) Losses: Definition and Example

What Are Mark-To-Market Losses?

Mark-to-market losses are losses generated through accounting entries instead of the actual sale of a security. These losses occur when financial instruments are valued at the current market value. If a security’s market price falls below its purchase price, the holder incurs an unrealized loss, and marking the security down to the new market price results in the mark-to-market loss. Mark-to-market accounting, part of fair value accounting, provides investors with transparent and relevant information.

Key Takeaways

• Mark-to-market losses occur through accounting entries rather than actual sales.
• These losses can happen when financial instruments are valued at the current market value.
• A decrease in price from the original cost results in a mark-to-market loss.

Understanding Mark-To-Market Losses

Mark-to-market provides a company’s current asset value by comparing it to the market value under current conditions. Assets prone to value fluctuations, such as stocks, bonds, residential homes, and commercial real estate, necessitate periodic revaluation based on changing market conditions. Mark-to-market offers a more accurate measurement or valuation of a company’s assets and investments within the context of current market conditions.

Mark-to-market contrasts with historical cost accounting, which uses original asset cost for valuation. Assets valued based on market prices fluctuate and don’t maintain their purchase price, making mark-to-market vital. If an asset’s price falls below the original purchase price, a mark-to-market loss must be recorded.

Mark-to-Market Accounting

The Financial Accounting Standards Board (FASB) governs mark-to-market accounting standards for US corporations and nonprofit organizations. SFAS 157–Fair Value Measurements establishes the definition of "fair value" and how to measure it according to generally accepted accounting principles (GAAP).

Fair value theoretically equates to an asset’s current market price. Under SFAS 157, an asset’s (or liability’s) fair value is "the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date."

Such assets fall under Level 1 of FASB’s hierarchy. Level 1 assets have transparent, fair market values that are easily observable. Stocks, bonds, and funds comprising securities baskets fall under Level 1 because they can be easily marked to market.

If the market values of securities in a portfolio decrease, mark-to-market losses must be recorded, regardless of whether they’re sold. The prevailing values at the measurement date establish the securities’ marks.

Other relevant FASB statements include:

• SFAS 115 – Accounting for Certain Investments in Debt and Equity Securities
• SFAS 130 – Reporting Other Comprehensive Income
• SFAS 133 – Accounting for Derivative Instruments and Hedging Activities
• SFAS 155 – Accounting for Certain Hybrid Financial Instruments

Market-To-Market Losses During Crises

The mark-to-market methodology aims to provide a more accurate view of a company’s asset value. During typical economic times, this accounting rule is routinely followed.

However, the financial crisis of 2008-2009 challenged mark-to-market accounting. Banks, investment funds, and other financial institutions held mortgages and mortgage-backed securities (MBS)—a bundle of mortgage loans sold to investors. When the housing market crashed, these securities on bank balance sheets couldn’t be properly valued.

Since there was no longer a market for these assets, their prices plummeted. Banks had to mark these toxic assets at current market prices, resulting in major financial losses reflected on their balance sheets.

Though banks and private equity firms were reluctant to mark these holdings to market, they eventually had to revalue billions of dollars worth of subprime mortgage loans and securities. These mark-to-market losses led to write-downs, totaling nearly $2 trillion, and triggered financial and economic chaos.

It’s essential to note that market-based asset measurements don’t always reflect their true value during price fluctuations. Additionally, in times of illiquidity, where there are few buyers or sellers, lack of market interest further depresses asset prices and worsens mark-to-market losses.

Real-World Example of Market-To-Market Losses

The 2008 and 2009 financial crisis saw a sharp decline in equity and real estate markets. Banks had to revalue their assets to reflect current market prices.

These revaluations resulted in significant mark-to-market losses. For instance, State Street Bank, an institutional investment bank, reported unrealized mark-to-market losses of $6.3 billion in their investment portfolio in January 2009. This represented an increase of $3.0 billion compared to the mark-to-market losses recorded on September 30, 2008.

State Street’s CEO, Ron Logue, in his 2009 interview with Reuters, attributed the decline in the bank’s stock price to the story of unrealized investment losses, driven by a lack of market liquidity caused by the financial crisis. Bad credit or loans were not the cause.