Posted on 03/12/2009 2:43:19 PM PDT by GreatDaggar
"Back during the Internet IPO boom, companies ranging from Netscape to Priceline to Expedia went public with no earnings to speak of whatsoever. Retail giant Amazon.com was jokingly referred to as 'Amazon.org' due to its lack of profits. Despite their heavy losses, investors bought into the aforementioned concepts based on the belief that in the future, their losses would turn into gains.
This is notable today given all the talk about mark-to-market (MTM) accounting. To its opponents, MTM lies at the heart of our economic difficulties. MTM naysayers argue that an accounting measure which requires firms to value assets at market prices discovered in very thin markets is in particular driving banks into insolvency. If a more liberal form of accounting were applied, presently insolvent banks would be healthier on paper and solvent..."
(Excerpt) Read more at realclearmarkets.com ...
ML/NJ
It wouldn't fix the underlying problem: too much sympathy for those who don't deserve it given by those who hunger for the power that sympathy provides at the voting booth.
Interesting.
This fellow has it wrong. The point of ditching the ‘Mark-to-Market’ rules is not to adopt ‘more liberal’ accounting rules. The problem with mark-to-market rules is that they exagerate both the ups and the downs of the business cycle. The rules force all financial institutions to behave like lemmings.
During the housing bubble, the mark-to-market rules made the bubble grow faster, by rewarding institutions that made risky loans that the market overvalued with high paper profits. Worse yet, now that mortgage securities are pariah in the marketplace, sound institutions that made only solid loans are being forced to join the stampede of panic, and mark their loan portfolios down, even when those loans are performing well.
The whole point of the marketplace is to reward and penalize individual strategic decisions. Some institutions may make investment decisions which seem bad today, but seem ingenious ten years from now. Other instituions make decisions that look good today but turn out disastrous. Mark-to-market declares no public financial institution can pursue a long-term strategy that disagrees with the collective wisdom of today’s marketplace. All profit and loss must be evaluated instanteously rather than letting a long term investment strategy play out.
The way I see it is Mark to Market is a Balance Sheet issue, not an Income Statement issue even if it does strongly affect the income statement.
What exactly is the purpose and users of a Balance Sheet?
Thank you, that was a very helpful post.
Negative. They reflect the true value of the asset at a set point in time. It is a result of exaggeration, not the cause.
Mark-to-market is a horrible idea precisely because it doesn't reflect the 'true value' of an asset. They force companies to make ridiculous instantaneous judgements about the 'true value' of their assets based on short term swings in the market, rather than rational long term decisions. This allows speculators, predatory market manipulators, and panicky investors to force companies to declare ridiculously huge profits and losses based on the short term whims of the marketplace, rather than a rational long-term strategy. We've seen oil surge from $70/barrel to $140/barrel and plunge to $40/barrel all within less than a year. Is the 'true value' $140/barrel or $40/barrel?
Now apply this to the banking industry. Suppose a big arrogant bank (let's for the sake of argument call it 'Citibank') decides to make lot of subprime mortgages on overpriced houses to people without provable incomes. Suppose a smaller more prudent regional bank (let's call it 'BB&T', because their CEO has been a vocal opponent of the TARP bailouts) continues to carefully check income and make conservative appraisals. Both banks convert groups of their mortgages to securitized assets which they hold on their books.
In 2005, when the market loves mortgage securities, the value of both banks assets rise, as they 'mark' their assets to the current market rate for mortgage securities. However, Citibank wrote many more mortgages because they made them to anyone with a pulse, so their assets rise much more. Their executives pay themselves big bonuses while BB&T's shareholders grumble at the paltry profits they are making compared to other banks.
In 2008, foreclosure rates skyrocket because of all the bad loans Citibank made in New York, California, Arizon and Florida. Investors flea from mortgage securities and market prices for those securities collapse. Citibank has some real problems to be sure, since some of their mortgages are truly bad. Those problems are compounded because the mark-to-market rules require Citibank to declare billions of dollars of losses immediately, rather than absorb the losses gradually over a period of years as the loans actually go bad. Of course Citibank is too big to fail, so their problems are nothing that a few hundred billion dollars of taxpayer TARP money can't solve. There's no sense in punishing Citibank holders with lower earning for years to come, when 'mark-to-market' rules can force taxpayers to solve the whole problem at once.
Now comes the really perverve part. BB&T's loans are all still performing because they were careful to make them to people who would pay their modest mortgages every month like clockwork for the next 15-30 years. Their cash flow is identical to what it was a few years ago. However, their assets are also in mortgage-based securities, which the market now hates. BB&T has no intention of selling those mortgage securities at today's prices; they intend to collect the modest profits from their carefully reviewed mortgages for years to come. Still, the 'mark-to-market' rules apply to them also. The market now declares mortgage-based securities are worthless, so they have to write down the value of their assets (and declare 'losses' on their balance sheet) just like Citibank does.
Now take this example and apply it to every industry. No executive in a publicly traded company can say "screw the short term fluctuations of the market - we're going to invest in this project because it makes long term sense and we'll be glad we did it 10 years from now". Their accounts will tell them "you have to value this investment at $X, because George Soros is selling short today and that's what the market says it's worth today.
'Mark-to-market' turns the whole point of free markets on their head. Rather than long term market decisions being the cumulative result of a large number of individual estimates of the true long term value of an asset, 'mark-to-market' demands that every decision-maker in the entire economy conform their decisions to the daily whims of the marketplace. It turns managers into lemmings.
Thanks for the explanation CaptainMorgantown
If Citibank and BB&T make different loans, then wouldn’t their mortgage-backed securities be valued differently? or are they considered the same and valued according to the same market?
And how does the securitization work? Do the banks give the cash flows from the loans to the owners of the securities, charge a price for the security and then assume the liabilities of the loans themselves? Do banks themselves hold a lot of these MBS?
And is the general opinion of the author right? Even if let’s say we get rid of M2M, is it really the silver bullet? Is it really one of the largest problems affecting the banks or is it just a good start?
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