Mark-to-market requirements turn into Doomsday machine
By John Dizard
Published: February 24 2008 22:02 | Last updated: February 24 2008 22:02
President Merkin Muffley: How is it possible for this thing to be triggered automatically and at the same time impossible to untrigger?
Dr Strangelove: Mr President, it is not only possible, it is essential. That is the whole idea of this machine, you know. Deterrence is the art of producing in the mind of the enemy ... the FEAR to attack. And so, because of the automated and irrevocable decision-making process which rules out human meddling, the Doomsday machine is terrifying and simple to understand ... and completely credible and convincing.
Dr Strangelove, 1964
There are so many smoking, sparking, and stalled bits of machinery in the credit markets that it’s hard to decide which is the one most in need of immediate attention. The most headline-attracting stripped gears have been the monoline insurers. Who would have guessed that the insurance regulators would find a way to intervene in that mess that would make a bad situation much worse? But they have.
There may yet be a negotiated solution to the monoline capital crisis. There’s a more insidious Doomsday machine tunneling under the capital structures of the banks and major dealers: the feedback loop of mark-to-market requirements on illiquid structured securities.
To quote Dr Strangelove: the requirement that banks and dealers mark securitised assets to market is “terrifying and simple to understand ... and completely credible and convincing”. Many now believe that like the fictional nuclear Doomsday machine, the unbending application of mark to market rules is not, in the end, a sane way to manage the world.
Here’s the problem: the mark-to-market rules assumed there would always be someone willing to buy or sell an asset at a price that bore some relation to the economic value it represented. This efficient price discovery process would provide the discipline to keep the financial institutions from being too cautious or too aggressive, relative to the economic circumstances of the time. Therefore, we wouldn’t need as intrusive a regulatory regime, with the inefficiencies of central planning and slow reaction time. The computation problems would be handled with better mathematical models, software, and data networks.
We will have lots of time on our hands over the next several years to argue why this didn’t work, since many people will not be as over-employed as they were. The reasons might include monetary policies structured to work only as long as certain governors were in office, politicians who wanted more home ownership than made economic sense, and the intrinsic greed and megalomania of speculators.
Right now, though, the problem is that the capital bases of the major banks and dealers are being reduced by losses on the mark-to-market value of securities faster than they can raise new money. That means that because nobody wants to buy a lot of the structured credit products, credit made available by the entire system could contract. That would lead to more losses, and a further contraction of credit.
We call that a depression. Yes, eventually you get to a level of prices where transactions will “clear”, because some people will have enough gold or soyabeans or yuan to buy the distressed assets.
http://www.ft.com/cms/s/0/a2631a20-e178-11dc-a302-0000779fd2ac.html?nclick_check=1