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The Mark-to-Market Melee
In recent weeks some have been arguing that just as Abraham Lincoln suspended habeas corpus in a time of war, perhaps regulators should suspend mark to market in this time of crisis. Paul Craig Roberts, a veteran supply-sider and former Reagan administration official, wrote on March 11 that the mark-to-market rule "is imploding the U.S. financial system by requiring financial institutions to value subprime mortgages at their current market values." His solution: suspend the rule, let financial institutions "keep the troubled instruments at book value, or 85-90 percent of book value, until a market forms that can sort out values, and allow financial institutions to write down the subprime mortgages and other troubled instruments over time." In other words, let's assign an imaginary happy value to these assets until the seas grow calmer. Steve Forbes echoed the sentiment in his column in Forbes, calling for a 12-month suspension of mark to market in "exotic financial instruments (primarily packages of subprime mortgages)." The reason: "It's preposterous to try to guess what these new instruments are worth in a time of panic." This line of thinking quickly wormed its way into McCain's big economic speech. He put it in more anodyne terms: "First, it is time to convene a meeting of the nation's accounting professionals to discuss the current mark-to-market accounting systems. We are witnessing an unprecedented situation as banks and investors try to determine the appropriate value of the assets they are holding, and there is widespread concern that this approach is exacerbating the credit crunch." For its part, the Securities and Exchange Commission issued an opinion letter in which it told firms, "[I]t is appropriate for you to consider actual market prices, or observable inputs, even when the market is less liquid than historical market volumes, unless those prices are the result of a forced liquidation or distress sale."
The language is technical, but the arguments here are simple and really quite silly—especially coming from folks who value market indicators over all else. These folks are saying that when markets are volatile and irrationally pessimistic, it's just not fair to force people to act as if the market prices are real.
But you'll notice that they never made that argument back when markets were irrationally optimistic, as they were from 2003-2006. No hedge fund manager ever told a bank that it should lend him less money because the value of the collateral he was putting up was clearly a product of unwarranted optimism or that he shouldn't collect management fees based on the assets under management because their value was clearly inflated. Nobody ever complains about the market's ruthlessness and inefficiency when it's making them money.
© 2008
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Member Comments
Posted By: tommy two tone @ 04/29/2008 4:48:41 PM
Comment: Here's the solution: protect the Insurers and other essential govt and quasi govt guarantors- Sallie Mae Included. Tell Wall Street to sue each other untill they have netted all their troubles out against each other. They took Bear out early, so at least that stink-bug is gone from the mess. The European banks may have to eat cake! To make sure it never happens again - regulate regulate regulate!
Posted By: tommy two tone @ 04/29/2008 4:48:23 PM
Comment: Here's the solution: protect the Insurers and other essential govt and quasi govt guarantors- Sallie Mae Included. Tell Wall Street to sue each other untill they have netted all their troubles out against each other. They took Bear out early, so at least that stink-bug is gone from the mess. The European banks may have to eat cake! To make sure it never happens again - regulate regulate regulate!
Posted By: tommy two tone @ 04/29/2008 4:43:12 PM
Comment: I believe that it's actually much more nefarious than your article would suggest. FAS 157 was known about for a long time befor e the credit crunch ensued. The date of Nov. 15 was set and the threat of consolidation from SIVs back onto the balance sheets of the "sponsoring " banks was in place as well (FIN 46r). The ABX index allowed for a mechanisim by which the ball could get stated rolling down hill- that being Goldmans's leadership of recommendations to their best clients (being tipped off to buy protection) -Paulson et al- in fact the ABX allowed for naked shorting of immense proportion (buying many times more protection than the actual outstanding bonds in he index) this is made possible becaue the premiums are soi lucrative to Goldman, and the buyer of the protection has to pay the coupon, until the default actually happens. Voilla' a Credit Crisis In full Bloom!