The Mark-to-Market Myth

Today the Financial Accounting Standards Board voted – by one vote – to relax accounting standards for certain types of securities, giving banks greater discretion in determining what price to carry them at on their balance sheets. The new rules were sought by the American Bankers Association, and not surprisingly will allow banks to increase their reported profits and strengthen their balance sheets by allowing them to increase the reported values of their toxic assets.

This makes no sense, for three reasons.

1. Investors and regulators are not idiots. They know what the accounting rules are. If banks claim they were forced to mark their assets down to “fire-sale” prices, investors can look at the facts themselves and apply any upward corrections they want. Now that banks will be able to mark their assets up to prices based solely on their own models, investors will the downward corrections they want. It’s a little like what happened when companies were forced to account for stock option compensation as expenses; nothing happened to stock prices, because anyone who wanted to could already read the footnotes and do the calculations himself.

However, the situation is not symmetrical, and the change is bad for two reasons. First, fair market value (“mark to market”) has the benefit of being a clear rule that everyone has to conform to. So from the investor’s perspective, you have one fact to go on. The new rule makes asset prices dependent on banks’ internal judgment, and each bank may apply different criteria. So from the investor’s perspective, now you have zero facts to go on. It’s as if auto companies were allowed to replace EPA fuel efficiency estimates with their own estimates using their own tests. We all know the EPA estimates are not realistic, but we can find out exactly how they were obtained and make whatever adjustments we want. If each auto company can use its own criteria, then we have no information at all.

Second, this takes away the bank’s incentive to disclose information. Under the old rule, if a bank had to show market prices but thought they were unfairly low, it would have to show some evidence in order to convince investors of its position. Under the new rule, a bank can simply report the results of its internal models and has no incentive to provide any more information.

So what we get is less information and more uncertainty. That was all reason number one.

2. Between the two options, this is the unsafe choice. Accounting in general is supposed to embody a principle of conservatism. Given plausible optimistic and pessimistic rules, you are supposed to choose the pessimistic one. But think about what happens here. Let’s say the bank has to mark to market, but it turns out the economy recovers and the asset increases in value. In this scenario, the writedown reduced the bank’s capital, so it had to get more. When the asset recovers, the bank is profitable and can buy back the shares it sold.

In the opposite scenario, the bank marks to its own imagination, but in reality the market price was the long-term price. At some point in the future, the bank will have to write down that asset, but it may not have the capital to absorb that writedown, in which case it will fail.

The choice is between the risk of raising too much capital and the risk of not raising enough capital. FASB chose the latter.

3. Mark-to-market is a red herring to begin with. Accounting rules are much more complex than “all assets must be marked to market” and “all assets can be marked to model.” There are different types of assets (Level 1, 2, and 3); different types of impairments to asset values (temporary and other-than-temporary); different accounting impacts (some writedowns on the balance sheet affect income statement profitability, some don’t); and, most importantly, different ways of holding assets. How a bank accounts for an asset depends in part on whether it says that asset is held for trading purposes, is available for sale, or will be held to maturity. Wharton has a high-level discussion of some of these issues, but if you really want to understand them you should read Sections 1.B-D of the SEC’s study of mark-to-market accounting, which I helpfully summarized for you in an earlier post.

The SEC’s conclusions were, in short:

  • Most bank assets are not marked to market to begin with, and half of the ones that are marked to market are the type that don’t affect the income statement.
  • Marking assets to market had only a very small impact on bank capital through September 2008.
  • The bank failures of 2008, including Washington Mutual, were not caused by marking assets to market (increasing loan loss provisions were a bigger culprit). In each case, stock prices started falling before the banks took writedowns, implying that investors already knew something was fishy before the accountants did anything.

I don’t know any of the back-room dealing, but it seems like the banking industry is taking advantage of the confusion to push through a change it wants, because it will make it easier for banks to massage their balance sheets and harder for investors to see what is really going on.

Update: Here’s a thought. What if the function of these rule changes is to make it easier for banks to ignore the results of the PPIP auctions? For example, Bank A puts up a pool of loans for auction, but doesn’t like the winning bid and rejects it; Bank A doesn’t want to be forced to write down its loans to the amount of the winning bid. Or, alternatively, Bank B sells a security to a buyer, and Bank A holds the same security; Bank A doesn’t want to be forced to write down the security to the price of Bank B’s transaction.

The change to fair value accounting (Rule 157) may make it easier to claim that the sale by Bank B was a “distressed sale,” meaning it can ignore it for valuation purposes. Even if it can’t ignore the sale, the change to other-than-temporary impairment may make it easier for Bank A to classify any impairment as temporary and therefore avoid an income statement hit. You’d have to be a specialist to know the answers for sure, but in any case these rule changes don’t make it any harder.

By James Kwak

135 thoughts on “The Mark-to-Market Myth

  1. Seems that the Republican talking point that the market declined over Obama’s first 45 days has gotten into the Administration’s head, and ever since they have done all they can to try to goose the S&P.

    How many times have we heard that the very strength of American markets is that we have rigorous accounting rules and serious penalties for fraud and insider trading, so investors can feel secure?

    Apparently, now is the time to throw out those rules, so there is enough opacity for insiders to manage results? Simon’s point about tunnels is particularly apt; the discretion to recognize losses at will is valuable, but the value comes from the ability to game people who don’t know any better.

  2. I listened to the FASB call and read the report. I fail to see how they are really changing things. Every news report I read refers to a comment in which FASB says a company can use “significant judgment”, which I believe is from this quote:

    “The Staff does not believe the Board’s intent was to change the objective of a fair value measurement. However, the staff believes determining fair value in a market where there has been a significant decrease in the volume and level of activity for the asset at the measurement date is inherently complex, depends on the facts and circumstances and involves significant professional judgment.”

    But if you read the original FAS 157 it says the exact same thing “Determining fair value in a dislocated market depends on the facts and circumstances and may require the use of significant judgment.”

    The other comment constantly used is referring to “orderly transactions” as though the use of orderly transactions changed but the original fair value definition stated:

    “fair value 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”

    I just don’t see a serious change if you read the fine print and not just conjecture from a bunch of newsprint.

  3. I completely agree with you, except for your statement that investors and regulators are not idiots. Recent history seems to me to have demonstrated the opposite.

  4. So we’re going from mark to market to mark to myth. Good chance banks pushed this through so they could mark up their toxic assets before dumping them on the government (taxpayers) and “private investors”. We, the sheeple, get fleeced again. That gravy train for the banks just keeps on rollin’.
    Someday someone will write a book about how the banks were able to pull this off.

  5. So, those of us out here in the hinterlands across the “big pond”, are going to read into this: Now, the government approved lying has now extended to not only cover the ratings agencies, but now the accountants, auditors and CFO’s are allowed to lie now too. You Americans are really a riot, ya know it? Here’s what I believe you ought to do next: allow ALL liabilities on every balance sheet, actually be reflected as an asset! Get it over with! Additionally, you should make ALL retirement benefits, accounts payable, payroll, and ALL expenses look like “sales” on your audits. This way, you can get to the finish line faster. And… you expect us to all take you seriously. Your a RIOT America!!!

  6. To argue that this change – to the extent it represents a change – impairs the fundamental basis of US economic growth tends to miss a key fact.

    Mark-To-Market was not implemented till 2007. The US experienced rather stable growth for a long period after WWII.

  7. James,

    It seems most of your comments “cancel each other out” except one. Since investors “are not idiots” they will figure this stuff out anyway. Additionally, since it is a “red herring”, i.e., the banks de facto had this power or flexibility anyway to not mark to market; then it also does not matter. The one point which does not cancel is “incentive to disclose information”. That could have been corrected by the FASB (I have not read it) by simply requiring certain disclosures. Hence, your argument really reduces down to “it does not matter that they changed the accounting rules as long as they maintain proper disclosure”.

    Clearly this rule must make it easier to mark up assets than the current one or they would not have done it, despite the “red herringness” of it. Liability risk re: Sarbanes Oxley may play a role in the new rule. I don’t really know.

    In my 30 years on Wall Street, including being one of the original 10 board members of the ISDA, I have always found this issue to be the most elusive. I have always had trouble determining the right answer. My bias, too, has been to be a “mark to market” accounting supporter. But as we move away from liquidity and simple price discovery, mark to market begins to lose meaning. So Eurodollar futures should be marked daily. Factories, buildings and land should not be marked daily—although when clearly impaired they should be. The question is how close to “Eurodollars” or “factories” are these bank assets in liquidity terms. And, how does liquidity relate to fundamental value?

    That is presumably why Firms are given the flexibility they have already. But today we have extremely high liquidity problems. As an aside, I believe these liquidity problems are actually being facilitated unintentionally by the Fed and Treasury through their guarantee and intermediation initiatives. It is analagous to welfare. The more we keep the market “protected” from risk, the more they are encouraged to not take it.

    But my larger concern, and the reason for writing this note, relates to the market’s understanding of the market values of the mortgages held by Banks. The bid/ask in terms of the “true” losses is $125 billion (William Lucy of UVA on domestic mortgages–his study is easy to find on the web and is persuasively descriptive) to %3.4 trillion (Roubini’s estimate–which may be global–not sure). That is a pretty wide spread.

    This implies to me mark to market in this environment has begun to lose its meaning. Not sure how this exactly relates to your point. But to me this financial crisis is about this “bid-ask spread” and the unwillingness or inability by anyone to make a strong case as to where values are. Personally, I find Lucy’s argument closer to the truth. The implications of this are pretty astonishing, obviously. What are your thoughts on Lucy’s study?

  8. My sense of Mark-To-Market is that it represents the “market-based” alternative to good regulation by attentive regulators. Leading into 2006, the consensus was that market-based solutions always outperformed command-and-control solutions. (The regulator shift in sulfur controls for coal plants is an often-cited example.)

    Recent volatility certainly put that assertion to the test – concerns such as depth of liquidity, short term volatility, market manipulation, etc. can have serious impacts on short term value of assets. An asset decline, in an of itself, can cause a run-on-the-bank, with immediate and drastic consequences.

    James’ primary counterpoint is that the impact of MTM is overstated because it does not apply to many of the assets under consideration. That is true, but there are a couple counter-points:

    1) The report notes that MTM resulted in asset value increases through the third quarter of 2008. It does not discuss asset values in the final quarter of 2007, nor the last quarter of 2008 – both very bad quarters.

    2) With very high leverage ratios – up to 25 to 1 – MTM can have a dramatic impact within an institution even if only a portion – say, 25% – of assets come under attack.

    Because markets project future earnings streams to expected net present values, small changes in characteristics of long term instruments can create large short term changes. For a bank already suffering from loan losses (that deplete its capital reserves), MtM accelerates problems.

    Notably, MtM is PRO-cyclical, not anti-cyclical. When times are good, markets overshoot and asset values are strong. There is no guarantee that MtM would have _prevented_ the crisis. Not at all, when the DJI hits 14k and everyone on wall street is getting drunk on profits.

    Good regulation needs to be anti-cyclical – putting the breaks on euphoria. It involves, indeed it DEMANDS, the recognition that markets are not always right – or at least that systemic robustness is a goal with value equal to (or greater) than short term economic efficiency.

    I do not contend that MtM (or the removal of the uptick rule) caused the crisis. However, there is a reasonable argument MtM accelerated it at precisely a time when we needed to slow things down. And it seems pro-cyclical, not anti-cyclical.

  9. I agree that this change is not as big as it might seem at first glance – hence my point #3 – but I don’t think it’s meaningless.

    I believe these are the docs:

    Click to access prop_fsp_fas157-e.pdf

    Click to access prop_fsp_fas115-a_fas124-a_and_eitf99-20-b.pdf

    On my read, the first clarifies the circumstances under which you can say a market is “inactive,” which enables you to use Level 3 instead of Level 1.

    The second quite clearly gives you increased latitude to decide whether an impairment is temporary or other-than-temporary. In the past, in order to avoid other-than-temporary treatment, you had to assert that you could hold the security long enough for the price to recover. Now all you have to do is (a) say that you don’t plan to sell the security and (b) assert that it is “more likely than not” that you won’t be forced to sell it. That’s a change in a legal standard and it makes it much easier to avoid classifying impairments as other-than-temporary.

    Banks always had a lot of room for judgment. Now they have even more.

  10. StatsGut, I’ve tried hard to read this as anything other than a non-sequitur (because I generally agree with your comments), but I still don’t get it.

    I’m not an accountant, but wasn’t growth for most of the post-WWII period based on assets that were either valued based on purchase price and depreciation, face value minus provisions for loss, or stuff that lived in heavily-traded markets? The rise of firms whose holdings are largely more esoteric and hard-to-price required the FASB to (belatedly) enact rules to better represent the realistic value of their assets. The rules may not have been perfect, but were better than the new change because of all the reasons James states.

    Now, the argument could be made (I wouldn’t, though) that we grew just fine before we had assets like this as a big part of anyone’s balance sheet and should outlaw them, but I think if we’re going to have them then in order to argue against mark-to-market rules you have to argue against one of James’ points, not just say no one was marking-to-market in the 60s and things were fine then.

  11. Wow! Will you economists PLEASE take a chill pill. The sky is not falling, the world is not ending, repeat after me, a post depression era refrain….. “Happy days are here again, …..” whatever. Krugeraand_man…. can you climb down off your horse?….. Obama win, K_man lose…… Happy daze are here again……

  12. Wait, do regulators not rely on GAAP valuation of assets for the purpose of assessing regulatory capital requirements?

  13. They have the flexibility to ignore GAAP valuation if they think it is creating inappropriate results, according to Floyd Norris’s article.

  14. There’s the argument I was hoping for.

    I think the caution that mark-to-market is pro-cyclical and we should be careful with it makes sense. Markets are very often wrong and market-fundamentalism is behind a lot of this mess.
    On the other hand, what does the regulation look like? Without mark-to-market, how can we expect the banks (or other firms with lots of mark-to-model assets) to let us know there is any trouble right up until the moment they say “oops, actually we’re worth far less than nothing, can the government please pay off our liabilities now? k thx bye.” – cue golden parachute.

    Is the regulator in charge of the models? Do we not let firms own anything the government doesn’t already have a model for? I don’t necessarily object to that, but I think the banks would scream a lot louder than they did about mark-to-market if anyone tried to put that in place. Then go about capturing the regulators so they could get around the model anyway.

    (Ps. Sorry I called you StatsGut, typo)

  15. I agree with your agreement on Statsguy’s very interesting point on cyclicality—-Each situation has its own characteristics, but this time the “pro-cyclicality” argument is hard to dispute.

  16. Much of the discussion on Mark-to-Market and Mark-to-Model is centered around the balance sheet and income statements and the effects thereon. But my take on this is a little different.

    These same cash-flow assets have been, and are, being pledged as collateral for borrowings that are short-term or otherwise. The problem then becomes that it would increase the risk of lenders that are lending against that collateral (where they would likely require the current market value) and would probably start freezing up lending markets – such as financial paper and short bonds unless the lenders could be certain they were covered.

    If I am not mistaken this was the cause of the Bear Sterns fiasco in the financial paper markets leading to the collateral calls that brought it down and further froze up the financial paper markets that completely stopped with the Lehman Brothers fiasco.

    So given that, could you offer any commentary on this issue of Mark-to-Model vs Mark-to-Market with respect to the use of these cash-flow assets as collateral? Perhaps, I am completely in the woods here and I could use that correction to my thinking. But as of now I am convinced that this is much more than an issue of balance sheets and income statements and there is much more to it.

    Thank you for your insight.

  17. So… we’re all on the same page that effective and counter-cyclical regulation > effective and pro-cyclical regulation, but what does it look like?

    Lots of regulation is pro-cyclical, especially in downturns, but we live with it. It would have been counter-cyclical to not let Madoff turn himself in and just tell him we’d bust him on the up-side… but that doesn’t make it good regulation.

  18. From page 143 of Wells Fargo’s 20009 Annual report (FAS rule 107):

    Mortgages held for sale $1,334 (million)
    Loans held for sale $5,830
    Loans, net $843,817 (that’s 843 billion!)
    Nonmarketable equity $11,104

    Deposits $781,402
    Long-term Debt $267,055

    Now wouldn’t you like not to have to print this table? Market capitalization is currently $65 billion.

    The lesson for investors seems simple: stay away from financial institutions.

  19. Robert,
    Yeah, and thats just ONE bank….there’s a LOT of them in the same boat. If this wasn’t so sad, it would actually be funny. Ah, how the Titans have fallen. Unfortunately, they took a LOT of us common folks down with them – NONE of the upside, but ALL of the downside. They wiped out pension funds all across the planet with this insanity. And you thought the world hated you 3-yeas ago? I think “The Obamanator” got a dose of his popularity over in London these last few days. They are lucky the city wasn’t burned to the ground. What amazed us over here in Europe, was watching the US medias version of the European citizens response to Obama. Your media played it up like we were all so glad to see him. You didn’t see Obama out waving to any crowds, did you? Guess why? YOUR media is part of the problem….trust me.

  20. To the extent that this FASB decision makes it harder for anyone to get credible information (and it seems this is the effect) this, sadly, shows how delusional policy-makers have become. A key force behind this crisis has been that an overwhelming number of people have stopped believing financial statements, period. If financial statements were credible there would be no toxic assets, because everyone would know or be able to calculate the current value of those assets.

    The FASB would appear not to have learnt from Japan’s experience of allowing its banks to define capital adequacy according to the price of securities (see p8; but overall the Mark-to-Model decision is a sideshow. No sustainable recovery will be possible until an overwhelming number of people can look at a financial report and feel very confident that it was written to help them, not hoodwink them. The FASB should be concentrating on achieving that, fast.

  21. Several years ago there was this prescient comment that America was pulling itself out of the tech bubble by inflating another bubble. Today, America is embarking on alleviating the fallout of widespread fraud by creating another wave of fraud.

  22. James or anyone who knows,

    Does the FASB rule change require the banks to at least disclose the model and the parameters they used to make the value calculation?


  23. 2007? I thought Enron was using MtM back around 2000, which is how it overinflated the value of it’s stock by using accounting that speculated that the future value of it’s assets were a lot higher, because they were using voodoo math to come to those conclusions?

    I read this today over at the financial times, and they also seem to think this is a rotten idea. The Dutch Securities regulator Hans Hoogervorst had this alternate, better plan..

    “The accounting standards setters should consider if this Economic Cycle Reserve can be shown in financial statements without compromising transparency. By clearly showing the countercyclical capital requirements as mandated by prudential regulators, the financial statement could give at an aggregate level a useful indicator for possible distortions caused by the economic cycle. If properly executed, this could help investors to look through the effects of the economic cycle on the financial statement.”

    So if i’m reading this right, he’s saying MtM would be ok if we put an asterisk by any reports that are based on internal valuations, so investors would know what numbers were more liberal. But no, now we’ve tossed that out and any number could be tossed out, if you have the right mathmatic acrobatics to come to your conclusion.

  24. Big Banks are very different now than they used to be. They mainly deal in securitizations, complex derivatives, and trading, as opposed to holding simple loans on the books. Basically, they are giant hedge funds and fully admit to being so. Can hedge funds mark their holdings to model? Is there even such a M2M discussion with regards to hedge funds? I’m sure many would like to, but fortunately such chicanery, is illegal, since it inevitably causes massive fraud, ala Madoff (who marked his book to his fantasy).

    So, to the extent that big banks are hedge funds, any revision of M2M is ridiculous and bound to lead to further fraudulent activity. Regional banks are another story, but they are mostly not the ones causing the problems.

    The fact that FASB has even had a ruling on this, shows how outrageous the government response has been to the crisis. Nothing constructive is being done at all and every rescue is merely an attempt to hide mistakes, print money,launder cash ala AIG, and cover up fraudulent banking activities.

    It’s incredible how the Market can rally on the face of this type of policy response.

  25. I admit it AA, it was all America’s fault. We are evil, dirty bastards who plotted to destroy YOUR continent’s wealth.

    OK, now that that’s settled, how about you post something constructive for a change? :)

  26. “As an aside, I believe these liquidity problems are actually being facilitated unintentionally by the Fed and Treasury through their guarantee and intermediation initiatives. It is analagous to welfare.”

    I think this is an important point. The US now guarantees credit card debt, bank debt, auto parts suppliers, and so on. How can this not crowd out private industry? I think the US should provide food stamps and housing vouchers and let people sort things out for themselves.

    Regarding the “bid ask spread” most bank assets are loans and thus still valued at non mark to market, but at loan minus loan losses. Thus most banks value their assets much more than the market would value those same loans if they were securities, right?

  27. “The fact that FASB has even had a ruling on this, shows how outrageous the government response has been to the crisis. Nothing constructive is being done at all and every rescue is merely an attempt to hide mistakes, print money,launder cash ala AIG, and cover up fraudulent banking activities.”

    Amen to that. Instead of killing bankers and lawyers (who facilitate securitizations and derivatives) we are killing the messengers. I did expect more from Obama.

  28. I will create
    1. Investor needs higher risk premium for investment in risky assets
    2. If there is shock, no banks can tackle that shocks because of value manipulation and it will create the biggest shock in the market and economy.

  29. > “more likely than not” that you won’t be forced to sell it

    This is the sticky point — even with undergrad-level statistics you can use different estimators to arrive at disparate likelihood measures. Combined with lack of disclosure this can look misleading on paper.

    This is slightly analogous to the models used by the bond raters’ algorithms which assumed the real estate market was “more likely than not” to continue growing, and as a result assigned AAA ratings to the toxics.

  30. My apologies, the comment was in response to:

    “How many times have we heard that the very strength of American markets is that we have rigorous accounting rules and serious penalties for fraud and insider trading, so investors can feel secure?”

    The point is that repealing MtM (if indeed it were being repealed) simply restores us (somewhat) to pre-2007 rules. If MtM were needed to guarantee growth through transparency, then how did we manage to achieve a faily long, stable period of growth after WWII?

    Either transparent and fair financial institutions were not needed to achieve growth, or we had reasonably transparent and fair financial institutions prior to the deregulatory madness that began in the 80s. I vote the latter.

  31. It does crowd out private industry, in the sense that if the crash had been allowed to proceed without govt. involvement, asset values would have fallen so hard and so fast that those who started the crisis in cash would have found themselves immensely rich upon the misery of the entire world.

    However, one could argue (I would in this case) that this type of crowding out is not always a bad thing in a crisis environment with high unemployment, falling commodity prices, and risk of deflation. The type of “investment” that is suffering from crowding is not socially productive. Moreover, by stabilizing the system it’s likely that govt. investment is actually _complementary_ to the type of good investment we want (long term investment in training, plant, equipment that anticipates payback as the economy grows).

    The classic crowding out argument is that when govt. raises taxes and borrows to fund govt. programs, this increases the costs of borrowing for private industry and inflates the prices of productive assets. This could be good or bad, depending on whether govt. programs are spending money more efficiently than private firms. The general consensus is that govt. programs rarely spend money more effectively than private firms. However, there is recognition that govt. programs fill needs that the private sector has little incentive to fill (such as providing a public good).

    [As an aside, the “market-based” response is to resort to contracting, but the various experiments with contracting have yielded mixed results – the problem is that govt. contracting simply shifts the locus of oversight responsibilities, it does not remove the need for oversight. Without good oversight, we have both corruption and incompetence in the contracting process – consider the case of Blackwater security, or various private prisons, or private banks scamming students with high cost student loans, etc.]

    So yes, govt. is probably crowding out private “investment” by refusing to allow home prices to fall so far that this bankrupts the middle class, the banks, and nearly every business in the US and many abroad. In the short term, good.

    In the long term, we face potentially deleterious effects as banks with govt.-subsidized capital can offer loans more cheaply than those without. This creates severe distortions, risks aggrandizing BoA and Citi just as we “grew” Freddie and Fannie – yet BoA and Citi are precisely the institutions we want to shave down! One can hope that when things stabilize, attention will turn to cutting these banks into pieces.

  32. One word:

    If you believe that mark-to-market always produces an accurate valuation, then really *was* worth $1.2 billion, despite never generating a profit and never having any *hope* of generating a profit. If you believe that mark-to-market always produces an accurate valuation, then you believe that all those dot-coms with no revenue, no product, no future actually were worth the millions of dollars that they got when their shares were floated onto the stock market.

    Personally, however, I prefer to look at the fundamentals of the investment, not what “the market” says it’s worth today. That kept me out of the dot-coms, that kept me out of the housing market during its glory days in 2004-2006 when it was clear to me that the valuations attached to homes by “the market” were utterly insane and unsupportable by the fundamentals, and otherwise has served me well over the years. Some of these securities that you’re advocating should be “marked to market” actually have far better fundamentals attached to them than “the market” is willing to support today, e.g. a $100K mortgage with 20 years left on it at 6.5% interest rate held by two six-figure-salaried professionals on a $500K home is worth a lot more than the pennies on the dollar that “the market” would be willing to pay for it today. And some of these investments are toxic trash that really *are* only worth pennies on the dollar (shrug). Point being, applying one be-all accounting rule to all investments, whether their underlying fundamentals are good or not, is utter nonsense and demanding that everything be “marked to market” is to insist that the dot-coms were properly valued because “the market” is never wrong. And folks who think that, probably bought stock too :-).

  33. These are the things we strive for, not only in our business relationships, but in all our relations with others: integrity, honesty, responsibility. That these are considered a bother by those who should know better does not bode well for any of us.

  34. “more likely than not” is a specific legal standard as per James’ comment, not simply a statistical measure. It implies an enforcement regime in which a regulator (or perhaps even a judge) would have the ability to weight the balance of the evidence and make a determination.

    If determination on the balance of evidence is left entirely to the bank, then its worthless. If that determination is left to the regulator, then it’s really a question of regulatory institution design.

    Note that one of the challenges with MtM is bank privacy. Bank privacy is so important that it’s one of the handful of exclusions allowed for the Freedom of Information Act. How can we expect the market to police (e.g. value) assets when they don’t know what banks are carrying on their books, and banks (even in this environment) refuse to open them due to threats to competitiveness and confidence? Thus, markets will be guessing, and guesses will be heavily influenced by sentiment (and rumors about inside information) due to lack of concrete data.

    Regulators, theoretically, could have much deeper access to information on bank assets. The question is how do they get that info from banks (when banks are no longer as pathetically dependent on handouts as they are today), and how do they use it? There’s a huge literature on optimal regulation and institutional design that pretty much got ignored when market mechanisms and game theory became all the rage in grad econ programs. Time to dust off Stigler, Train, and those other greybeards.

    A longer term question is how to make sure that when regulation falls into disfavor, the banks can’t free themselves of their shackles. That is where Simon’s argument about “too-big-to-fail” really has merit, and where we need to start considering rules against revolving-door jobs in govt./financial sectors.

    It’s not about creating yet another super-regulator with super-powers, but creating a system of rules that is more stable than a system of people. Something like the civil service laws. We do not need to have transparency into what the regulators are actually doing inside the banks, but we do need enough transparency to know that regulators are not subjective to perverse incentives (perky jobs after retirement or excessive Congressional pressure) and are reasonably competent.

    Without these kinds of institutions, a standard like “more likely than not” is toothless.

  35. I definitely agree that we had “reasonably transparent and fair financial institutions prior to the deregulatory madness that began in the 80s”.

    However, I think the things that changed were both a “deregulatory madness” and the development of financial institutions full of new types of assets (and institutions that could make money creating and selling these assets to others, but that’s another story). The fact of the matter is that these assets exist and we as an economy have to price them in some way and explain them to shareholders who want to invest in companies that hold them (or declare that some or all classes of companies can’t hold them).

    The pragmatist in me says to stop worrying about what the past looked like and start talking about how we fairly price these damn things or fairly and fully stop systematically important companies from holding them.

  36. Don’t listen to him adios.

    I was wondering about that–Obama looks more stressed than someone with jetlag…he actually looked afraid when i saw him in the news today. i wish i could have sympathy, but i really dont–i think he is a puppet to all of the special interest groups he pretended that he didn’t want in Washington.

  37. <<>>

    Ahhh, now would this be the same captured regulatory SEC that refused to investigate Madoff, Stanford, and countless similar schemes? The same captured agency that fired its own investigator Gary Aguirre for following leads to possible insider trading involving Wall Street heavyweights? The same captured regulator who “studied” the 70 year old uptick rule and deemed it unnecessary? The same captured agency that was handed over 5,000 complaints of naked shorting and excused them all? The same captured agency that let the short based hedge funds basically write the joke of Reg. SHO and followed it up with zero enforcement.

    To better make your points, I’d suggest not referring to lying, captured agencies as sources of “fact.”

  38. Addendum to my post… An excerpt from the blog was left out between the at the start of my comment. That should have in it, “…but if you really want to understand them you should read Sections 1.B-D of the SEC’s study of mark-to-market accounting… ”


  39. It’s true that if you cannot fix your accounts just try to fudge them…
    I read in the G20 communiqué:
    “We have provided significant and comprehensive support to our banking systems to provide liquidity, recapitalize financial institutions, and address decisively the problem of impaired assets. We are committed to take all necessary actions to restore the normal flow of credit through the financial system and ensure the soundness of systemically important institutions”

    Ok now they call them “impaired assets”, but does relaxation of accounting standards address the problem? It does not appear so. Is it a necessary action to restore the normal flow of credit? It does not appear neither necessary nor sufficient.

    Then we read “to take action, once recovery is assured, to improve the quality, quantity, and international consistency of capital in the banking system. In future, regulation must prevent excessive leverage and require buffers of resources to be built up in good times;”
    Does a change in the accounting standards improve quality, quantity and consistency of capital in the banking system? For sure it does not improve quality whereas it may improve quantity, buying time for the held to maturity assets hoping that they will recover values. About consistency, it appears quite clear that there is none.
    I still contend that to the extent that a change in accounting standards increase the information asymmetry in the market for lemons, it will be difficult to find a price of equilibrium for the toxic assets. Moreover I think that the impairment of information content of banks account and the privately held information embedded in toxic assets will paradoxically defeat the objectives of the PPIP. So either banks will not be interested to sell toxic assets anymore or if they want to sell them there will be a further distortion in prices and it will be more likely that they are selling lemons.
    I conclude saying that I do not see how the same managers who screwed up the accounts of several banks can be given another tool to reduce transparency and increase risks of those same accounts. It’s more than a conflict of interest…It’s a pity that we are loosing opportunities to create new “good banks” defending existing ones against taxpayers

  40. This is an interesting comment, as I believe one can use the same exact argument to show why banks should be bankrupted immediately and why M2M is the way to go.

    Why If you believe that the market was right in that was worth $1 billion, why didn’t the government come in and bailout Why didn’t they bailout

    Answer: Because at some point the Market recognized that these companies were worthless. Yes the Market did that. Not the government and the final market prices were 100% correct. They are worth ZERO!

    So yes, market prices are sometimes deceiving, but can only be a for a short period. This is why companies don’t write off assets immediately. But when market prices for assets are near $0 for over two years and keep going down, it’s logical to assume that market prices are 100% correct.

    The assets that banks are holding have been seen as near worthless for a long time. If they had any worth investors would be buying them already. Moreover, most of these assets were conceived in fraud, just like and were. Therefore, these banks should go the way of and

    It is idiotic that the government is throwing trillions of dollars at saving institutions that are completely filled with morons and where the vast majority of derivative transactions are conceived fraudulently.

  41. Sam, your argument is that _eventually_ the market will get it right, although it could be drastically wrong for years.

    Society can afford the luxury of this level of volatility and innacuracy for companies like

    Society cannot afford this level of volatility for companies that provide basic social/physical infrastructure.

    Banking directly affects the entire social system. Money is the legal mechanism for facilitating complex transactions and for scoring how much wealth societies owe to individuals and firms (and to each other).

    The failure of this system is not merely the failure of a single firm, but the failure of much of the contractual basis that undergirds a modern economy.

    The idiocy is NOT that the government is failing to treat Bank of America like WebVan…

    The idiocy is that we ever thought we could use the same free-market tools to discipline Bank of America that we use to discipline a web startup. We know – and BoA knows – that we cannot rigidly apply market discipline without causing immense harm to ourselves and the world.

    Market discipline is enacted through an implied threat of bankruptcy, and that threat is not valid when everyone knows the cost of carrying through with the threat is overwhelming. This is called a “commitment problem”.

    And even if we could commit, I’m not sure we would want to! Commitment only addresses the _rational_ side of the argument. EVEN IF we did impose magnificent harm on ourselves for the sake of punishing BoA through market mechanisms, we have no guarantee at all that BoA’s employees and investors will act rationally when the entire world is acting irrationally.

    That puts a great deal of faith in human rationality, when we have (now) thousands of studies demonstrating just how irrational our brains are.


    humans are semi-rational (boundedly rational)

    social systems are incomplete (information and transaction costs, limited ability to fully specify contracts and all contingencies)

    economic systems are dynamic, not static

    Moral of this crisis: for systems that are fundamental to social/economic infrastructure, build them for robustness, NOT efficiency.

    Economics students should be required to read Herbert Simon.

    But heck, if you think the banking system is dangerous, consider a few other systems:

    Health care: Exactly what free-market incentives would encourage hospitals to adequately prepare for a massive flu pandemic? Or require kids to get vaccines so they don’t infect _other_ kids?

    Agriculture: To ensure against drought/natural disaster, the world must consistently target production levels in excess of our expected needs. What incentive do farmers have to do this?

    Attempting to apply unmodified free-market rules to certain economic sectors is disastrous.

    Friedmanomicons are currently arguing that the problems is not MtM or other aspects of the market, but rather that we _did not go far enough_ in applying rigid free-market rules to critical economic sectors.

    These arguments are grotesquely wrong and dangerous.

  42. Very good post but it misses a key point. In the real world vast swaths of debt securities are actually held to maturity buy the huge dreadnoughts of the financial system (back when we had such things). For them MtM only caused meaningless variation in reported valuation. In other words, it wasn’t real, but they had to take action based on the “non-real” values posted under MtM (like dump names that may well have paid at maturity in 5-10 years). It was a poorly thought out spasmodic reaction to Enron’s collapse, when Congress needed to seem relevant to an angry electorate, and then leaned on FASB. (Sound familiar?)

    I wrote about it here…
    RIP Mark to Market


  43. What I mean by the what I called bid/ask spread is really the estimation range of what the real underlying mortgage losses are/will be on US housing–versus the mark to market value on the books of banks themselves.

  44. Your point is valid. Banks do operate like hedge funds, at least some portions internal to the banks do. Compared to actual hedge funds, these operations are abominations. Where a hedge fund charges 20%, these firms effectively charge 50-60%–which tends to be the payout ratio for banks as a whole. Secondly, there is double taxation to the investor on the activity. Finally, they take advantage of “bailout nation” through extreme moral hazard actions—extreme leverage. There is too much capital in the financial sector. I disagree with statsguy on his The capital needed to be wiped out of the banking sector–there is no “there there”— except excessive risk.

  45. Addressing your points one by one:

    1.) There is no way that investors have as much knowledge about the assets on the books as the banks themselves do. The idea that they will be in as good a position to judge the value of those assets is pure fantasy. As far as “Fir Market Value” being a fair and consistent rule, that is silly as well. Do you really believe that the same valuation methodology should be applied to a security where millions of shares trade hands every day as to a security that experiences a single trade in 2 years? There are thousands of commercial loans that had to be written down on the books of CLO’s because one nervous lender made a decision to get out no matter what, despite the obligor being current on all payments and at little risk of default.

    2.) Mark to market for certain securities was enacted in 2007. For the 50 previous years institutions did fine without it. Definitionally, implementing mark to market was less conservative than saying the course (and yes, I am aware of the accounting definition of conservative…I believe my statement holds up to scrutiny).

    3.) There are differences but FAS 157 was applied to a whole range of assets that had little to no liquidity. It was mis-used and mis-understood by the accountants.

    Finally, do you not find it wrong that a simple accounting change was able to exact so much damage? This is because an accounting convention was allowed to have regulatory implications, which never should have occurred. The government needs to set its own standards so as not to be subject to the whims of outside forces in this manner.

  46. “Seems that the Republican talking point that the market declined over Obama’s first 45 days”.

    Its not a “talking point”, its a fact. The market declined from 9625 (election day) to its present 7950 and was as low as about 6700.

    Since we know markets are forward looking, its not a vote of confidence.

  47. This is from the SEC’s summary of accounting rules prior to yesterday’s change:

    “Debt securities that a company purchases with the strict intent and ability to hold until maturity may be designated as held-to-maturity . . . HTM securities are recorded on the balance sheet at amortized cost. Declines in fair value are not reported in the balance sheet or income statement, except when the security value is impaired (the carrying amount is above fair value) and the impairment is determined to be other-than-temporary.”

    Now, the current crisis has caused impairments in many debt securities. so the question is whether banks must admit that the impairments are OTI. The existing rules already allowed banks to avoid MtM treatment if they could credibly claim that they would be able to hold the securities to maturity. The problem is, that was not a credible claim for many banks, and in that case, the decline in value is not “meaningless.” Yesterday’s change made it easier for a bank to avoid marking to market, even though it may not be able to hold the securities to maturity.

  48. Am I a conspiracy theorist for wondering why—despite all the talk early on in the crisis about eliminating the M2M rule and reinstituting the uptick rule—we do these two things AFTER we print and borrow trillions of dollars to bailout institutions holding toxic assets and AFTER we devise a 90/10 marketplace of gov’t and private equity/hedge funds to purchase these (now not so toxic?) toxic assets from these institutions?

  49. Huh? 2007? You’re not an accountant, are you? Market prices have been used in financial statements for decades and increasingly so since the 1990’s. I think you are referring to SFAS 157, which has nothing to do with when mark-to-market was used. SFAS 157 merely contains guidance on how to value elements to market.

  50. I think you are misunderstanding me. I am not saying we shouldn’t regulate banks and just leave it to the Market. We absolutely should regulate these banks. In fact, these banks should not exist any longer. They should have been bankrupted long ago.

    My only point is that when Market prices are very low for certain assets for a long period of time, the rational reason is because these assets are nearly worthless.

    The fact that .com’s soared in value for a few years, is not important. At some point, they failed. If the government came in to save WebVan and when they were at pennies on the dollar, and made an argument that the prices didn’t reflect reality since e-commerce was booming, people would have laughed in their faces.

    But, at the same time when the government comes in and throws trillions at banks which have failed, and make a claim that the toxic assets have value greater than the market price, people take them seriously.

    I for one think the banks are worth less than the .com’s that failed. At least the .com’s created something useful for society. The big banks do not on the whole create anything useful for society. Society would function just fine with alot of small banks making local loans.

    In reality, anyone who has worked in finance can tell you that the toxic assets held by big banks are priced correctly by the Market, if not too highly. This is not a liquidity issue.

    Many, many, CDS’s, CDO’s and the like were originated with intent to defraud and enrich the banks based on short-term and ludicrous assumptions. It was a scheme to pay huge salaries. There is no difference between this and some .com flameout who business plan was based on hot air.

    If Jeff Bezos ran the Treasury and Jerry Yang was the Fed Chief, I can assure you that the .com’s would have had their $1 trillion bailout as well.

  51. It’s amazing how many people fail to realize that M2M were enacted due to the dramatic change in big banking in the 90’s.

    Many of the arguments against M2M here are valid for the pre-90’s, pre-CDS, pre-CDO banking boom.

    But, in the new world of banking, arguments against M2M are simply crazy. These banks don’t want to and will not hold loans to maturity. They trade loans. That’s the whole point of CDO’s, CDS’s and dozens of other ludicrous credit derivative inventions by big banks. The credit derivative boom, and now bust, also explains why nothing that Bernanke does works anymore. He too is applying pre-1990’s Fed policy, to what is clearly a whole new type of crisis that nobody has ever faced.

    I highly recommend reading Traders, Guns & Money: Knowns and unknowns in the dazzling world of derivatives by Satyajit Das. This book opened my eyes as to what was and is still happening at big banks.

    Until I read that book I also had no clue what was really go on.

  52. Agree. The big banks themselves admit they are hedge funds. There is way, way too much capital in the financial sector.

    Think about what $3 trillion would do for cancer research, for alternative energy, or for any other great and meaningful cause.

    It is very, very sad, that the people running our government have respect for one thing: Imaginary Paper.

    They fear that imaginary paper created by low IQ bankers will cripple society, so they give trillions to bankers who proceed to pocket that money and buy townhouses in NYC.

    Doctors and scientists should threaten the government with a walk out if they don’t get trillions, and then we’ll see how society really functions.

    Sorry, but bankers are an imaginary threat. They add nothing to society and are just parasites.

  53. The fact that the regulators have that flexibility doesn’t mean they will use it. And their judgments about when to use it are likely (for political reasons) to be pro-cyclical. In fact, in practice, the regulators do base capital requirements on GAAP.

  54. I see your point James, It is substantive and well thought out. But I’d add that the impairments further deepened the crisis causing the need for more impairments forcing asset sales, causing more impairments, and so on….It’s the death spiral of MtM.

    In practice the onus was to argue for other treatment and that burden lead to a bias to marketplace valuation.

    While the rules certainly allowed for an argument against MtM, the fear of being “Andersonized” by the profession lead to a bias towards a “Bloomberable” value. That’s just how the conversations would go under MtM. It was very frustrating dealing with a self inflicted wound like this. Hence my term “meaningless.”

    As you know, significant number of securities that are performing (and that will continue to perform) were priced at $0 in the market, (and under MtM have to be carried at $0) because of the presence of one or two sub prime elements.

    The psychology of MtM trumped the reality of the option to argue for different treatment.

  55. >>” There is no way that investors have as much knowledge about the assets on the books as the banks themselves do. The idea that they will be in as good a position to judge the value of those assets is pure fantasy.”

    Absolutely …

    I’d add… Especially when they are scared and irrational.

  56. I like this blog but this post and your post are just wrong. M2M was applied way too broadly to asset classes that are not even close to being as liquid as, say, publicly traded stocks. As a close observer and participant in the commercial CLO side of the business, I can tell you first hand that trading activity has little to do with the true value of a loan. When a market is as thin as some of these were, you simply cannot view it through the same lens as the NYSE or other similar high-volume extremely deep securities market.

  57. That’s a slightly unfair assessment of Ben. The tools he has access to are limited by laws, which constrain his response.

    Even so, he has deployed some new tools to address the liquidity concerns in the system (buying commercial paper was a big move, for example). Perhaps too little too late, but it has had an impact.

  58. Rule 157, as I believe other people have pointed out, was a clarification.

    This Statement applies under other accounting pronouncements that require or permit fair value measurements, the Board having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this Statement does not require any new fair value measurements.

    The rules that required fair value accounting, and the rules determining when it was required, already existed. Rule 157 clarified the techniques one would use to measure fair value. I don’t buy the argument that Rule 157 was a change that triggered the financial crisis.

    Also, existing rules (before yesterday) already allowed financial institutions to ignore distressed sales. There were published rules that determined when you could ignore a sale and use Level 3 data instead. So a single sale by one panicked investor would not necessarily trigger massive writedowns for every other investor holding that security. Yesterday’s change established a specific test you use to determine whether a sale was distressed or not. By reducing uncertainty, that may have been a good thing. But it’s not the case that the old rules meant that you always had to mark down to match every market transaction; nor is it the case that the new rules say you can ignore any market transaction.

    Finally, rule 157 is supposed to be applied to assets that have little liquidity. It says that for illiquid assets, where there is no available market data, you use Level 3 data. The real issue, which does matter, is when you have to use Level 1 (market) data and when you are allowed to use Level 3 (model) data instead.

  59. I totally agree with your assessment; however, i was not overly surprised by this development

    the Europeans managed in Ocotber to achieve something similar with re calssifying assets… is a complete no-brainer as it all it does is increase uncertainty and encourages non-disclosure

    For these sorts of reasons, and equally daft proposals like Geithners recent toxic assset plan, I am inclined to believe this will be an enduring downturn with a weak recovery

    The mind boggles….did the US learn nothing from the S&L debacle when accounting rules where changed and just increased the total cost to the taxpayer

    Very disappointing news indeed, this is

  60. I agree, but I’m not comparing this to a deep securities market. There are many illiquid markets out there.

    In fact, I invest in alot of illiquid securities and even private companies. If the price of the investment sinks and does not recover within two years, there is obviously a reason. If I have a big loss, it’s likely I made a mistake in my reasoning and I search diligently for the flaw in my reasoning. I do not suddenly wake up and ask the government to bail me out and allow me to reprice the securities I invested in to any price I deem as appropriate.

    The people running the big banks are simply immature and they are costing society big time. Somebody needs to stand up to these fools. They had a great run, made loads and loads of money, and now they’re losing. So we should bail them out by allowing them to make up their own prices for the securities?

    Makes no sense. Take your losses. And let’s move on already. Enough of these cover ups, bailouts, mark to model bs.

  61. Sam, your rationale makes little sense in an illiquid market. If the price never came back up it could be because one party made a very bad trade and everyone else values the security at a much higher level. Or, as I experienced on a daily basis, a piece of a loan trades hands because the seller had to get out but its stream of cash flows are not at risk. One trade simply can’t convey the information about all of the holders’ expectations for the asset. Why should I take a loss on a loan that I fully expect to pay out?

  62. The relevant market for residential mortgage-backed securities right now is the residential housing market. There is no market for most of the RMBS that institutions hold. And there is near-complete opacity on a lot of them. It is surprising how many positions the banks have about which they are essentially clueless concerning the distribution waterfalls in the PSAs. They wanted rated securities tied up in a nice bow, with a range of weighted-average lives, and off they went, never bothering to try to figure out what would when it started to look like somebody other than junior might not get paid. And everybody is convinced that their class will get hit. But they aren’t all right.

    They’re terrified to sell because they don’t understand what they’ve got, and terrified to buy because they’re afraid the other guy might understand what he has.

    So you get these crazy spreads. They aren’t based on asymmetrical informantion, they’re based on mutual ignorance.

    And when you consider the CDOs, it gets exponentially worse in terms of opacity.

    M2M has no place in a “market” like this, IMHO. There is no market, and there never really was. The securities were pretty much snowflakes, although that was rarely acknowledged until the shit hit the fan, and they traded individually pretty infrequently, truth be told. The “market” was mostly based on initial public and private offerings, and those have of course stopped completely.

    Yes, accounting is about conservatism. But the relevant market here is the housing market, and how many defaults are occurring, and how severe losses are being observed in foreclosure — and what is the likely future worst case. That and then running the resulting cash through whatever series of waterfalls that you have in order to figure out who’s going to get what in whatever you determine to be the worst case.

    This sort of non-mark to market approach doesn’t involve judgments about enterprise value, or future sales, or whether XYZ Corp. is going to take over ABC, Inc. or the viability of some untested idea or technology. You have a large number of debt instruments that can generate a finite maximum amount of cash by a date certain, which cash flow will be reduced by prepayments, default frequency, loss severity, and foreclosure expenses, and you need to apply statistics and large numbers to determine where the worst case outcome is likely to be.

    The biggest problem I have with this, actually, is the haplessness of a lot of the analysts I run across, who seem unable to read pooling and servicing agreements with understanding. It does not give a lot of confidence in their models.

  63. Needless to say, it matters a lot whether the underlying loans are in one of the big bubbles, like say southwest Florida, or in a region that has held up better.

    And that is one more level of opacity. So all buyers assume every loan is secured by a house in Las Vegas.

  64. Come to think of it, I wonder whether anybody has ever studied how much secondary trading there has EVER been in private label MBS. Damned little, I’ll bet, except in bulk when one institution was acquiring another.

    When everything was going up, the “analysis” was all about prepayment speeds, and even then it was done on a macro basis judgment based on the underlying pool weighted average coupon. The really “sophisticated” analysts made adjustments to their prepayment expectations, again on a macro basis, based on the mobility and refinancing behavior of borrowers in different parts of the country if a pool was concentrated geographically. Nobody ever did any particular analysis of credit losses, and how they worked through the waterfall. And a CDO where the underlying assets are themselves RMBS or CMBS, with two different levels of waterfalls to work through? Forget it.

    “Just tell me whether they’re triple B or single A” was the attitude.

  65. Well, it’s OK. I just wish I still had all the Euro’s that were stolen from my pension fund when we bought the Americans mortgage securities….My wife, kids and I really wish we still had the 30-odd years of savings that were once there, securing our future. But…it’s been stolen. But Hey! We’re still alive! Unlike the tens of thousands of dead civilians that have been murdered by the taxpayers in America….The Beautiful.

  66. What shall I post Phil? As Americans seem to love being lied to, here’s a lie for you: We ALL love you. Now…shall we all sing “We Are The World”? I’m really sorry Phil if my truths are getting you upset. You want to be upset Phil? I would like you to talk to my wife and kids, who are now wondering why the managers of our pension fund were so trusting of America The Beautiful. Yes, we were very stupid to do that…..a mistake we will NEVER make again. But just remember Phil…we actually ARE the world. And we’re DONE with you. Why don’t you just screw yourselves for a change, and leave the rest of us out of your nonsense “investments”? We have actual lives to lead over here, where we try not to KILL other people in far away places that did nothing to us…..can ya’ give that a try maybe, Phil?

  67. If the price never came back up, that means that other people value it at a higher price?? I honestly don’t understand that. If they think it is worth more than the current price, why don’t they buy it?

    Why should you take a loss? No reason. You never have to take a loss. But, if you need the money to run your business, and/or investors/creditors demand money, you may be forced to sell. In that case, you either take the loss if you are a real company or if you are bank you steal money from the taxpayers to cover your loss or you get the government to change the law so that you can make up any price you want for the security.

    If absolutely nobody in the world will buy a particular security at anywhere near what you say the price is, the conclusion is either you are lying about the worth of the security or everyone else in the world is nuts. You can then decide to hold on to the security forever if you so please, as long as you don’t need any capital. But that doesn’t mean that the security is worth what you think it is.

  68. New Tools? He is printing money. Perhaps, he has invented new fancy names for printing money, but basically that’s all he is doing. Nothing original. Printing money always works for a time, how can it not, but eventually it implodes on itself as it’s not sustainable. Will the Fed print trillions of dollars every year from here until eternity to support the banking system? Why not just print $15 trillion and forget about the whole real economy. That would be nice, then all of us can be like bankers and not do any work and just sit back and collect checks from the Fed.

  69. If there was no market, how did bankers pocket hundreds of billions of dollars, if not trillions, of bonuses over the last five years peddling this garbage?

    When the market goes up, it’s great to have market prices. When it goes down, well let’s forget about the market.

  70. Stats,
    Have you ever BUILT something that another humanoid would may want to purchase? Rather than selling derivitive swapped, asset backed, reverse leveraged, senior debted, equity leveraged, reverse mortgaged, mezzanine financed, senior-junior-freshman(?) equity enhanced asset valued credit defaulted BULLSHIT? Make something. Build something. You may find that’s where the future actually is…..just a thought. Selling nonsense has proven itself thru the ages. Those who engage in nonsense inevitably starve in the end…..but they usually have quite a bit of fat to live off of for a while…..but not enough to last forever.

  71. I’m developing some new material, but waiting for the next bonehead move by the Titans Of Finance, to take it out for a drive.

  72. I hear the Chinese are coming to America to take advantage of the “fire sale” prices on your homes. I guess the real question is, do you think the Chinese leave their Christmas tree lights (made in China) up over the front door up all year? I wonder of they’ll but out Walmart now, so they can actually own the retailer that sells all their stuff to you fools.

  73. We call it “ChinaMart”. Sells only the finest slave labor produced goods (if you like lead in your toys and poison in your pet food).

  74. I think changing the rules now will just give chapter eleven to the whole scam…M2M was a brilliant way to drive out Lehman and Bear, give Goldman & Morgan a free pass with their biggest competitors gone, and all the while the makers of the mess probably have an island or two, prerefunded munis, gold and Singapre currency, from the large salaries they drew by leveraging up the shareholders balance sheets X40– no Sarbanes, no Racketeering, just a montra that we need these banks more than life itself.

    Now that the firms they ruined have cost our country 12 trillion plus, they don’t mind changing the squeeze that helped create the crisis which gave a reason for the big 12 trillion bailout– meeanwhile, Rick Wagoner of GM got kicked in the teeth and sent on his way while our new savior puppet president is selling cars….we live in a corrupt country when our President can perpetuate this corrupt plan.

  75. A few tasty tidbits to satify the masses that giving free money via AIG and all the rest indeed was OK! Sorry for Ben!HA–he has lost all of his shy shaky voice to a confident one now that he and his frind hank have pulled off the biggest heist in history! Same for hank–prior to the heist he was timid with a shaky voice in public–after tarp 1, his voice was smooth and steady!

  76. Top two operation manuals for the fed:

    1)”How to make pretend money legally”

    2) “How to use monetary policy to the greatest advantage of the primary dealers who implement the market manipulation.”

  77. Adios,
    Have you ever WRITTEN something that another humanoid would want to read? You just write emotional stuff trying to trash other people. Why don’t you do something useful.

  78. What market? No one really knows how much actions by the fed influence markte prices and then all the lemmings jump on board—monitary policy is legal market manipulation.

  79. Curious,

    You forgot a few:

    3. When your creditors finally catch on to the Ponzi scheme that is, in fact the reality of the American economy, how do we use our position as the reserve currency to default?

    4. How to back future generations earnings, so we can buy more crap from K-Mart today.

    5. How to appropriate 35% of the real economy for government spending nonsense that benefits the Lobbyists, who are the people who really write the laws, and pay us bribes.

  80. It was easy to pull off Tom. The American citizens will absolutely sit on the sidelines and let it happen. It’s what they do. The founding fathers would probably now hang their heads in shame. They never figured that the government they put in place would become, basically, a tool of the elite class. Dump the junk on the average citizen when it goes bad, and take all the profits by creating a false economy. Then, count on the passive American “spirit” to pull it off. Brilliant actually.

  81. Mike,
    You perhaps hit the nail on the head. If they are bailed out this time, whats the message being sent to future bankers, not to mention the current band of thieves? THEY rolled the dice, we all lost, and they had ZERO downside under the current concept of Bailout Nation. And this nonsense about “The sky will fall if we don’t do this”, is clear, utter BS. It’s about bailing out the monied elite of america, plain and simple. WHY you are all not marching in Washington is beyond my comprehension.

  82. Ray,
    My point was that the U.S. has been viewing it’s financial sector, as an actual industry….which it’s not. “Finance” is a service, that got somewhat out of hand. It seems like every kid in America wanted to open a hedge fund, rather than be a fireman or a baseball player. Manufacturing Chia Pets and light bulbs is industry. Selling fraudulent financial instruments to unsuspecting global consumers….is clearly not industry. It’s fraud. Plain and simple. GO MAKE SOMETHING AMERICA. That’s probably your solution. So, you bail out the banks, you fix a few roads and bridges, and you install a few solar panels…..then what? The next bubble? Great…..I can’t wait.

  83. Curious,

    As usual, I agree with you. Why don’t people just face the reality that there is no magic pill or silver bullit to resolve this mess? We left our free markets to the whiz kids, and look what happened? I’ll make a bet here and say 80% of them still have no clue what they were doing. Had no idea how they got us so close to the edge. And now, they offer solutions? THE solution is very clear. Let the losers lose, and pick up the pieces and move forward. But…..the real risk NOW is that the losers refuse to lose, and they are very powerful. So, the games continue….but this current concept? Just another scam to keep the losers from losing. It’s very clear what this is about.

  84. What ever happened to “……….and the home, of the, brave?” Isn’t that in your “big song”? Where the hell are all those brave guys when you need them?

  85. Sam:

    “If they think it’s worth more why don’t they buy it?”

    Because it is illiquid and they can’t. That’s the whole point. Just because someone makes one bonehead trade for whatever reason does not mean that the limited group of holders will all do the same thing. That’s my point. One party selling a security at a discount does not make that price available to everyone else that wants to buy at that price. If that were the case, it would not be an illiquid market. Price discovery and the ability to enter into a transaction are very, very limited in many of these markets, making M2M completely inappropriate. We’re not talking about exchange traded securities here.

  86. Does anyone realize that these large banks had been offering and buying Islamic Shari’ah Compliant Financial products (SCF’s) since at least 2001? SCFs are overseen by Islamic “scholars”, different in each institution. SCF’s are described as non-transparant and “complicated”. Instead of charging interest, they charge “fees” that can be “renegotiated” every so often. I Heard Clark Howard talking about some home loans that Chase Bank had given—with low fixed interest rates. Then when they found out the rate wasn’t cuttin’ it, they “renegotiated” for a $430 yearly fee. The buyers were outraged…don’t know whatever happened…but it sounds like SCF to me–just not named so. I think SCFs got the banks in a mess and CEOs had hide their “trade secrets” because if the American public ever found out we were financing terrorists with American taxpayer dollars we would have a revolution. But if they just make it more non-transparant, it will be even more like SCFs and harder for anyone to figure out and the Saudis will have even more control of our banks and we can finance more anti-America jew haters and hasten on the global Islamic takeover! (it is a well guarded secret how much of our capital market and bank shares the Saudis have–because they bribe and extort so well!)

    Think of all the files that were lost on 9-11, showing who the real imperialists are–and what kind of deals…I suspect “toxic” SCF tranactons between American businesses and Saudis from the 1970’s to Sept 10, 2001.

    Sheik Qaradawi, a terrorist banned from entering the United States and Great Britain, who leads international Islamic Finance agencies describes Shari’ah finance as:

    “I like to call it Jihad with money, because God has ordered us to fight enemies with our lives and our money.”

  87. OOPS, i should have noted that the instruction manual number one should resd “How to print money for the cartel/monopoly to pawn off to the public, in exchange for their work, and assets.”

  88. Over the long term, Sam, you are correct, a market system will often wobble wildly between extremes of undervaluation and overvaluation but the long-term mean will be closely correlated to the true value of the underlying assets. Of course, over the long term, we are all dead.

    The problem with simply allowing the banking system to collapse due to the fact that we’re currently on the undervaluation side of that wobble (remember, only three years ago these exact same assets were *overvalued*) is the same today that it was in 1932 — a banking system collapse causes raging deflation. Banks are somewhat unique in that banks *create money* via the mechanism of fractional reserve lending. And a free enterprise system relies on having a stable token representing value i.e. a stable money supply, which implies a stable banking system, otherwise you introduce inefficiencies and distortions into the marketplace. Trading the actual goods (barter) simply is too clumsy and cumbersome when you consider the astoundingly long series of barters that would be required to place this personal computer upon your desk. You just can’t run a modern economy that way.

  89. Why don’t we just cut to it straight away and realize that it is not about valuing (toxic) assets, but about hiding the true performance of bank managers.

  90. I disagree with the assessment that this is “a new kind of crisis that nobody has any idea how to face.” The reasons why Ben Bernanke’s actions are failing has nothing to do with the crisis being some “new kind”. In fact, John Maynard Keynes correctly identified, in 1937, the reasons why Bernanke’s actions are failing, which can be summed up via the phrase *propensity to spend*. If the freshly printed money that Bernanke is printing up merely disappears under mattresses (whether physical or virtual — e.g., recent Federal Reserve report that most of Bernanke’s freshly-printed money is, in fact, merely sitting on deposit at the Federal Reserve because the banks are just keeping it on deposit rather than lending it out), then it does nothing to foster economic activity and as far as the greater economy is concerned doesn’t exist. It has the same effect as raising the reserve requirement at the same time as printing fresh money — i.e., no real effect upon the money supply because the new money is getting offset by the old money being destroyed by the rise in the reserve requirement. And this mattress-money situation is going to continue as long as banks and individuals believe that the money will be worth more to them in the future (due to deflation, unemployment, or because in the future the economy turns up and the money can then be lent out at a higher interest rate) than it is worth today in terms of goods and services purchased or loan returns if lent.

    The solution was also predicted by Keynes: i.e., rather than just handing out money, hand it out with strings attached which require it to be spent. Thus an increase in food stamps (which are now distributed as credit cards which expire at the end of each month, i.e., you can’t save them up) results in a far greater increase in economy activity than simply throwing $100 bills out of the window of a helicopter. The $100 bills, in today’s economic situation, would get stuffed under mattresses either real or virtual. But spent on food, the money has to be spent to purchase food from farmers, haul it to the processing plants, process it, haul it to the stores, hire shelf stockers to put it on the shelves, and hire cashiers to ring up the purchases, it can’t just disappear under a mattress. Same deal with handing out a contract to build a bridge. The money has to be used to buy steel, pay construction workers, and so forth. It can’t just disappear under a mattress. As it was in 1937, so it is today. Fundamentals of economic activity have not changed, only a few of the details.

    I believe that many of these complex instruments need to be outlawed and unwound back to the naked instruments representing particular actual physical assets, otherwise it is simply too difficult for either the market or for institutions to properly value them, but to go from there to claim that we are in some sort of “uncharted territory” is nonsense. We’ve been here before, almost exactly, in the time period 1929-1939. A few details different does not mean that we’re in “uncharted territory”, any more than me changing the fender flares on my Jeep and putting bigger tires on it means that I have a new Jeep. Err, no. A few details different doesn’t make it new, sorry.

  91. Because it’s not exactly true? As someone pointed out above, less than 5% of the assets held by banking institutions are currently held as “mark to market”, thus your notion is nonsense — a change in the valuation method for less than 5% of the assets held by banks is not going to do a whole lot to hide the true performance of bank managers.

    As pointed out above, many of these “toxic” assets actually do have value because the underlying securities that they’re based upon have real rates of return (e.g. the income inflow to a pool of mortgages) and the market over the long term would properly value them if you take the mean value of the valuations attached to them by the market. It’s just difficult to properly value them according to their long-term returns if you’re forced to mark them to short-term market value, where the market is currently dysfunctional and undervaluing them in much the same way that, three years ago, the market was dysfunctional and *overvaluing* them. The proper action is to a) unwind the complex securities back to the underlying “bare” asset-based securities, and b) value them according to long-term returns, not according to short-term market fluctuations. (a) isn’t happening right now (but should), (b) is what the new accounting rules explicitly sanction (it was always possible to do (b), but was discouraged for some assets by the accounting board because of the Enron fiasco).

  92. Those less than 5% of total assets could mean bankruptcy for a bank, given that their equity value is close to 5% of assets!

  93. I’m not knowledgeable enough to judge the effects of this change. But three things are clear to me:

    1) It’s an act of deregulation, and its effects (if any) will be to enable near-bankrupt companies to hide their debts and continue digging themselves deeper into their holes.

    2) This was pushed for heavily by various CEOs of probably-soon-bankrupt companies. I don’t trust their motives. And I don’t like the fact that their advice/demand was acted upon so instantly.

    3) It’s now official: nobody beyond the lunatic fringe believes that ‘the market is always right’ anymore.

  94. I agree that things are hard to valuate. But if markets cannot accurately value specific assets, how on earth could you expect them to be able to valuate entire companies? And why do we still find influential people who believe that the total market valuation of the stock market is some useful indicator of the overall economic situation?

  95. Yep! Goldman, Morgan, Citi, RBS, Bear Stearns, Lehmans, AIG, the Fannies, Madoff were all, and those that are standing are still being, as the names of these companies imply, run and led by Saudis.

    Blo**** Hell! Isn’t anywhere where we can be safe from Israeli lobbyists?

  96. There is always a market out there no matter how “toxic” or “illiquid” the asset may be. The “dysfunctional market” is a nice term used by those who won’t sell at a price that a buyer will currently pay for them. They think it is worth more or that the price will recover. For those who invest in the stock market have a look at your own portfolios. You may notice some highly liquid stuff losing maybe 30% to 70% of what you paid for it. How many of you are sitting there thinking that the price will recover?

  97. Just wanted to point out that in the Board’s comments from its April 2 meeting, they acknowledge that significant changes to the FSP FAS 157-e version that was put out for public comment would be reflected in the final version. A couple of these changes seem to temper the provisions in the draft that were perceived as a “relaxing” of the application of fair value accounting. First, the presumption that transactions in illiquid markets are distressed will be removed. Instead, such determinations will require consideration of available evidence. Second, when a change in valuation technique results from applying the FSP (i.e. presumably level 1 inputs are foregone in favor of level 3 inputs), the entity must disclose the inputs associated with the new technique and estimate the effect of employing the new technique (i.e. disclose the valuation that would have resulted based on the level 1 inputs). I tend to agree with others that the new FSP will not, in practice, result in valuations that are significantly different than those that would have otherwise resulted from applying FAS 157, I think these changes are appropriate in that they may improve the transparency associated with any divergences from standard FAS 157 based on the FSP. That said, I am generally skeptical of such divergences for the reasons James outlines.

  98. Badtux,

    The only problem with your logic is that the six figure income people are now being laid off. In fact white collars jobs are now being lost at a greater rate than manufacturing or retail.

    When most of your workers are laid off, middle management the next logical group for redundancy.

    There have been some excellent discussions on the fact that old models no longer work in this economic environment. My questions is how will the banks new modeling for MTM be considered a true reflection of the markets.

  99. I like update at the end of the post. I also wonder about further interaction between mark-to-model and PPIP. As Stiglitz’ recent op-ed pointed out, the PPIP auctions will be pricing options on the assets, not the assets themselves. And due to the problem of adverse selection, banks may say “I sold my really toxic assets for $X. I still have some mildly toxic assets that I think are twice as good as the really toxic assets I sold, which I will value at $2x.” The fact that X is an option value will make the picture even less clear.

  100. Can anybody help me? I couldn’t find any restriction in PPIP for a bank willing to offer an asset to auction being forbidden to buy shares from the fund willing to buy those assets.

    Am I blind or only bad informed?

  101. If not for the issuance of FAS157 effective November 15,2007 by the SEC and FASB . For those unaware fair value was redefined. This rule requires banks to mark to market instead of mark to model as previously calculated since the inception of FASB. Pre FAS 157 when an investment vehicle trades thinly (such as mortgage backed securities) the underlying holder of the investment is allowed to use its own assumptions on fair value, today it must be valued based on what it can be sold at in the open market. If I’m a bank and expecting to receive future cash flow of $1000 a month over the next 30 years on an loan of 200K for a total payment of 360k, based on todays fair market value and panic in the market the underlying issue has been written down to 40 cents on the dollar or approximately 80k and this is a conservative figure.

    In the current market it would not be wise to sell any of the troubled assets based on fair market valuation as there are not enough buyers which drastically reduces the price of the asset.

  102. at least through 2007, US Morgan was prevented from supporting “religious’ based products. But, that didn’t prevent them from dedicating full efforts for SCF products in their Dubai branch.

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