The Trouble with Mark-to-Market

nationalreview.com ^ | March 12, 2009 | By the Editors

[litehaus]

Hells Bells....MTM is like putting in a ‘sell at market’ order before the market opens when you see $50 bid and 65 asked.....You gotta be desperate or dumb to do it......Yeh, the buyer will be happy and you’ll sustain the loss cuz you were “forced to sell at the market??”

[brytlea]

Give me a reasoned explanation, not just a soundbite. I really would like to hear what you have to say.

[AmusedBystander]

Mark to Market works fine in normal times, but when panic ensues everything is being sold at fire sale prices. Thus pulling down the value of everything when in reality many of these investments do have value and cash flow. Suspending MTM for a short time would basically give the big boys some breathing space to get things sorted out. Many of those mortgage bundles have positive cash flow and a temporary way to measure that and adjust values to those would be better than just simply writing every thing down to some bargain basement value and running everything into the ditch.

[dfwgator]

My point is that before Mark to Market, banks were leveraging too much, without carrying enough liquid capital reserves. Without the discipline of Mark-To-Market, they would have continued, and things would have been even worse.

No, MTM didn’t avoid the catastrophe entirely, but it may have been even worse, had it not been in place.

Now going forward, the banks that do survive will have to have enough liquid reserves. Remove MTM and it will go right back to the way it was. Rinse. Lather. Repeat.

In a nutshell, I think MTM forces banks to make better decisions.

[javachip]

We need a way to properly value the untradable instruments but I want to keep MTM.

Your statement is a perfect demonstration of the key flaw in mark-to-market. There needs to be a functioning market to provide the basis for a valuation. By definition, there is no market for an untradable instrument, so it can't be properly valued with a mark-to-market system.

Under mark-to-market, banks are forced to value their securities lower every time some other bank has a fire sale to raise capital. Doesn't matter if the security is performing, the market value just changed so the value on the balance sheet changes. If the value drops too much, the bank has to raise capital. Can't raise capital? Sorry 'bout the Friday visit from the FDIC.

As an analogy, suppose there was a clause in your mortgage that required you to have cash in an account to cover any negative equity. Then a neighbor's house goes into foreclosure and is sold at auction. Based on that new comp, you're now underwater on your mortgage and need to raise money. Doesn't matter that you're current on payments or that nothing else has changed. Can't raise the money? Sorry 'bout that, you go into foreclosure. That's the scenario banks face under strict mark-to-market.

This shouldn't be that complicated. The accounting standards board should be able to come up with some guidelines on when mark-to-market isn't a viable valuation method, e.g. the last price for similar assets was a forced sale. For transparency, require the bank to state why they can't mark-to-market, explain how they valued the asset and provide a footnote in their financial statement stating what the value would have been under mark-to-market.

[dfwgator]

Also, I am operating on the assumption that once MTM is removed, it’s gone for good. It won’t be temporary.

[dinasour]

> I think the problem is that most people (including me) don’t really understand exactly what it does.

Let's suppose that MTM applied to you, instead of your bank.

Say you're a successful bankruptcy attorney and times are pretty good. You bought a $1,000,000 house and have a $700,000 mortgage. You are paying your bills and even have $100,000 cash in the bank.

All of a sudden, Barney Frank shows up with a new assessment on your house, which says it's now only worth $500,000.

He's says, “You're bankrupt!”, and takes your house, your car, your bank account and leaves you standing under a bridge with a bill for $100,000.

Something like that.

[dinasour]

The other side of the story, is

Before you were a successful bankruptcy attorney, and before MTM rules were in effect, you worked at Enron.

At that time, you had a $500,000 house that you falsely claimed to be worth $1,000,000. You used that as collateral to borrow another $700,000 which you blew in very speculative deals.

When you creditors came to collect, they found out that you really never had squat.

[brytlea]

As usual, we’ve seen the enemy and he is us.

[brytlea]

See, that makes sense when you say it.

[truth_seeker]

What difference does it make?

Market to market; or NOT market to market,

if the government is going to bail you out anyway?

[brytlea]

My financial adviser is home, so I’m going to try to explain what he’s telling me. He said it needs to be suspended. When MTM was put in place there were no assets like the CDOs and such. As a result, while MTM worked for the asset classes that were MTM at that time, and does create some protection against over leverage (that worked really well, right?), right now, the CDOs and similar investment vehicles cannot be MTM because the market is so fearful of them that while everyone acknowledges there is value over a multiple year period, there is no real market for them. Thus, banks are having to mark them down at zero or very close to that when their real value will clearly be higher but banks are forced to write down assets and realize a loss that is materially ficticious.
Most bankers are not asking for the elimination of MTM as they recognize the value. What they are asking for is a modification to take into consideration these unique assets. This is what Jimmy Diamon, the SEC and FSAB discussed today in front of Congress.

[brytlea]

Oh my, if Barny Frank showed up and said anything to me...well, it wouldn’t be pretty! LOL
Thank you for trying to explain it to me. :) I wish I were smarter!

[EVO X]

so how come the economy was just fine all these years before MTM?

The mortgage industry weren't running wild pushing NINJA and negative equity loans.

[ari-freedom]

you’re making another assumption which this addresses:
http://online.wsj.com/article/SB123672700679188601.html

There is a difference between suspension of mark-to-market accounting for regulatory capital purposes and suspension for disclosure purposes. So let’s have the disclosure but let’s not have regulators shut down the banks