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. Mark-to-market losses can occur when financial instruments held are valued at the current market value. If a security was purchased at a certain price and the market price later fell, the holder would have an unrealized loss, and marking the security down to the 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.
Mark-To-Market Losses Explained
Mark-to-market as an accounting concept has been governed by the Financial Accounting Standards Board (FASB) via the board's various statements: 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; and SFAS 157 - Fair Value Measurements. It is the last one, issued in 2006, that holds the most attention of auditors and accountants, as the statement 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 current market price of an asset; according to SFAS 157, the fair value of an asset (as well as 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. 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.
Market-To-Market Losses During Crises
The purpose of 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 by banks, investment funds, and other financial institutions as well as investors who had a shareholding interest in these entities because they could not bear to take dramatic mark-to-market losses in markets that they deemed highly illiquid.
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), but eventually, the billions of dollars worth of subprime assets that they owned had to be reckoned with. They created them, dealt them and held what they failed to sell on their books. The mark-to-market losses of the banks precipitated unprecedented financial and economic chaos.