How to Understand the Mark to Market Rule

When something is dry and obscure as an accounting role makes the headlines. And you know that we’ve got something serious going on. Mark to market is one of those accounting roles that I’m sure you heard in the news lately while drinking your coffee and watching Jim Cramer or Matt Lauer, but what it is mean especially in the context of this whole good assets bad assets discussion. Oh that’s what here to talk to you about in a ghost story. It’s called When Mark Went To Market. Here it goes. A young artist named mark left at home with his parents. He sold his arts to schools and just need the crayons and copier paper to create additional pieces of art. The money that he made from his art was just enough to allow to buy new crayons to create additional pieces of art. “But I’m never going to become a big time artist just by making crayon art.” He will admit it one day. So he turned to his parents to borrow money. His parents being pretty savvy business people got him a deal. So his mother said, “You’re able to earn and buy $100 worth of supplies right now, right?” Mark agreed. So his mother continued, “Will lend you another $100.00 so that you can buy $200.00 worth of supplies. Well, Mark was so excited when he heard this. “Wow! Mom I can buy brushes and water colors and oil canvasses and sell to corporations and rich art lovers and.” “Now hold on son.” said his dad. “We have a ground rule so that we don’t lose all of the money that we lend to you.” Mark sigh, “What’s the ground rule, dad?” And this is what his parents agreed too. “You’ve now got $200 in your pocket. $100 is not yours it’s ours.” said his dad. “You can use that $200 to buy whatever supplies you want and to create whatever art you want.” said his dad. “But at the end of everyday, your mom and I need to run a calculation to put our minds at ease that you’re not down the path toward losing all of your money.” Mark side “Well, what’s that calculation dad?” “We put in a $100.” said his father. “That’s what we lent you. You put in a $100 that’s your equity steak that you’re starting out with. Your equity cannot fall below 25% of the present market value of what you own. If it does, we’ll make you sell everything.” Mark side remember years of his parent trying to explain methodical things like that to him. “You know what this may not come as a surprise to you but I don’t get it.” His mom and dad look at each other. “Just go do your business and we’ll help you figure it out along the way.” So Mark went about his business, leaving his parent wondering if their business jeans get to generation. The next day, Mark to the art store and bought paint, canvasses and painting supplies like brushes. Mark started to paint when at the end of the day his parents sat and down to figure out the present value of everything that they own. So his mother asked, “If you sold everything in this room today that you bought with that $200, how much would you fetch for it?” Mark grumbled, “My parents are so hard core.” he thought. “Well, I lightly used the brushes and the paints, but what I painted would have some value if I sold it today.” he thought. “So, if I have to resell my supplies and sell this painting that I’m working on I get about $190.00 easily.” So his mother calculated it. “25% of that is $47.50 and of the $190.00 that you could fetch today $100 is what we your dad and I loaned you. So subtract that and your equity today is $90 right?” “$90 is more than $47.50 so you’re good Mark, carry on.” Mark blinked his eyes and shrugged his shoulders. “Okay.” And he continued to paint. Mark was successful and staying above the 25% maintenance margin and managed to sell his new paintings for $210.00 He repaid his parents the $100.00 loan, repaid himself his $100 equity stake and pocket it the $10.00 profit. But Mark became restless he heard that there’s this new buyer at this exclusive modern art facility that maybe interested in art made from unique things like credit cards. Pieces like that hadn’t been sold to often in this neighborhood thought, but he thought a risk like that may pay off hugely if he got a piece in that facility. So mark borrowed more from his parents. He borrowed $200.00 this time and still just used %100 of his money to buy $300.00 worth of supplies. In other words, $200.00 was a loan and $100.00 was his equity stake. He borrowed more he was leverage more. At the end one day, his mother asked, “Okay, Mark you know the drill. If you were to sell of these things in here today, what would you fetch?” “Well” Mark wasn’t sure what credit card art would sell in the open market today. So he assume that day that this would fetch approximately the same amount as this other napkin art piece fetch at the same art museum. It’s a sort of strange to use a different piece of art to price what his art would be, but his art didn’t trade that often. So instead of marking it to the market he had to market to a model that was similar to what he was trying to sell. A big hole in the whole Mark to market thing, but Mark had to do something to satisfy his parents. So Mark estimated using that napkin art piece as a model that he would fetch $250.00 of his original $300 investment. His parents were skeptical but they assume that Mark was being fair and honest. 25% of the $250 he would fetch today is $62.50 and $250 less his parents $200 loan is $50. $50 was mark’s remaining equity stake. His mother side, “Mark, honey $62.50 is greater than your current equity stake at $50. So I have to call it Mark you have to sell everything now.” That’s the margin called by the way. Mark panicked “But mom, credit card artist doesn’t buy too often, but am I going to do I can’t get rid of this today.” His mom said, “You have to figure something out because you owe us $200.00 we can lend your sister money and we can’t lend your sister money unless we get that $200.00 back from you. So Mark tried to sell the credit card art, but no one was buying that kind of art today, and if art buyers made an offer they will only going to pay in pennies because they knew that they couldn’t sell that art either. He took a gamble and now he had some bad art on his hands that he couldn’t get rid off which put his parents in a predicament too because they couldn’t lend money to his siblings unless they got their loan back from Mark. Mark was annoyed that he was forced to his to sell based on the present day value of his credit card art when that kind of art piece is in bought too often in the market making it hard to value. So applied for a loan from the government using his bad art as collateral hoping that the money that government gave him would allow to paid back his parent and give him time for a decent market for the credit card arts develop. And also give him some cash so that he can sell some risky art and give him self back on his feet. But was putting at present value on his art during a period when his art was tough to value fairly the right thing for his parents to do at that time that it kicked Mark from continuing down a risky path? Or did it just cause a crises because he couldn’t sell that art that day? That’s the mark to market debate that we’re hearing right now, and it’s surrounding more in back securities, collateralized dead obligation and other bad asset that are tough to price right now, and for tough for companies to sell and get all their bucks. I hope the story help put some clarity around that debate. It’s still on going right now, and I’m looking forward to seeing how it’s going to end up. So that’s the end of the story and I hope you come back again.