Monday, March 16, 2009

The Mark-to-Market Rule

You may have been reading about the mark-to-market rule in connection with the travails of the banking world. It applies to real estate in a very unfortunate way, which helps to explain why appraisals are so problematic these days.

Very simply, mark-to-market means that the value of an asset should be governed by what other similar assets are worth. Since most homes are only valued when they are sold, or refinanced, most people would expect to be unaffected by changes in valuation when they are not in the process of selling. However, the current focus on "stress testing" banks, and the influx of the TARP money, has caused regulators to take a new look at the revaluation of assets already on the books of those banks, and revalue them based on the basis of recent transactions or valuations at other banks.

Let's assume that there's a house on your street that went into foreclosure, or even just got sold to a relocation company when the owner moved. Since either of those scenarios would favor a quick sale, it might well have changed hands at what you would consider a rock bottom price. The mark-to-market rule, however, would then dictate that your home is now worth what the relo company sold your neighbor's home for, at least insofar as they are comparable properties.

You can easily see how things can spiral downward from there. If you then had problems with your mortgage, your bank would be carrying the value of your home at the "new" value, making your home further underwater. If every other bank then writes down the homes they have financed on your street, pretty soon everyone is underwater on their mortgages, and the banks have way more in the way of "troubled assets". All this is true even though perhaps only one or two homes changed hands at the lower value, and maybe not even in an arm's length transaction. The next thing you know, another bank is below recommended capital requirements, and is on the endangered list. At that rate, every bank may end up on the list, when the only thing that happened is that one home in a neighborhood got sold at a bargain price. Scary, right?