Mark-to-Market (MTM) Losses: Definition and Example (2024)

What Are Mark-to-Market Losses?

Mark-to-market losses are losses generated through an accounting entry rather than the actual sale of a security or other asset. For example, if a security was purchased at a certain price and the market price later fell, the holder would have an unrealized, or "paper," loss, and marking the security down to its new market price would result in the mark-to-market loss. Mark-to-market accounting is part of the concept of fair value accounting, which attempts to give investors more transparent and relevant information.

Understanding Mark-to-Market Losses

Mark-to-market is an accounting technique designed to reflect the current market value of a company's assets. Many assets fluctuate in value, and periodically, businesses must revalue their assets accordingly. Examples of assets that have market-based prices include stocks, bonds, residential homes, and commercial real estate.

The goal of mark-to-market accounting is to provide investors, lenders, and other interested parties with a more accurate measurement, or valuation, of a company's worth.

Mark-to-market stands in contrast with historical cost accounting, which uses the asset's original cost to calculate its valuation.

Mark-to-Market Accounting

Mark-to-market, as an accounting concept, is governed by the Financial Accounting Standards Board (FASB), which establishes the accounting and financial reporting standards for corporations and nonprofit organizations in the United States. FASB issues its standards via the board's periodic statements.

The statement known as SFAS 157–Fair Value Measurements provides a definition of "fair value" and how to measure it in accordance with generally accepted accounting principles (GAAP).

Fair value, in theory, is equivalent to the current market price of an asset. According to SFAS 157, the fair value of an asset (or a liability) 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 the hierarchy created by the FASB. Level 1 assets are assets that have a reliable, transparent, fair market value, which is easily observable. Stocks, bonds, and funds containing a basket of securities would be included in Level 1 since the assets can easily have a mark-to-marketmechanism for establishing fair market value.

If the market values of securities in a portfolio fall, then mark-to-market losses would have to be recorded even if they were not sold. The prevailing values at measurement date would be used to mark the securities.

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

Mark-to-Market Losses During Financial Crises

As mentioned, the purpose of the mark-to-market methodology is to give investors a more accurate picture of the value of a company's assets. During normal economic times, the accounting rule is followed routinely without any issues.

However, during the depths of the financial crisis in 2008-2009, mark-to-market accounting came under fire. Banks, investment funds, and other financial institutions held mortgages as well asmortgage-backed securities(MBS), which are a basket of mortgage loans sold to investors as a fund. These securities were held on bank balance sheets but couldn't be valued properly because the housing market had crashed.

Since there was little market for these assets any longer, their prices plummeted. And since financial institutions couldn't sell the assets, which were considered toxic at that point, bank balance sheets took on major financial losses when they had to mark-to-market the assets at current market prices.

It turned out that banks and private equity firms that were blamed to varying degrees were extremely reluctant to mark their holdings to market. They held out as long as they could, as it was in their interest to do so (their jobs and compensation were at stake). Eventually they had no choice but to revalue their portfolios, which in the case of some major banks held what were at one time billions of dollars worth of subprime mortgage loans and securities.

The mark-to-market losses led to write-downs by banks estimated to have totaled in the trillions of dollars. The result was financial and economic chaos.

It's important to note that market-based measurements of assets don't always reflect the true value of the asset if the price is fluctuating wildly. Also, in times of illiquidity–meaning there are few buyers or sellers–there isn't any market or buying interest for these assets, which depresses the prices even further exacerbating the mark-to-market losses.

Real World Example of Mark-to-Market Losses

The 2008-2009 financial crisis provided many of the most vivid examples of mark-to-market losses.

A more recent example came from the collapse of Silicon Valley Bank in March 2023. The principal cause of the bank's failure was its large holdings of long-term government bonds and securities. While relatively safe, the securities lost market value when interest rates on newly issued securities rose. The bank had been listing them on its books as HTM, or held to maturity, securities, which allowed it to value them at their historical prices. However, when it had to liquidate a portion of its portfolio, accounting rules forced it to revalue the entire portfolio using the mark-to-market method.

When word got out about the bank's losses, worried depositors withdrew huge sums of money, leading to the bank's swift collapse and takeover by the Federal Deposit Insurance Corporation.

The Bottom Line

Mark-to-market is an accounting technique intended to reflect the value of the assets on a company's books at a particular point in time. If the assets have declined in value, the company will have mark-to-market losses on them, although it won't realize those losses unless it sells them.