Mark-to-Market: The Bogeyman of the 1930s Is Back - BUT - it's not a "must-use" rule.

[JohnWxy]

The banks are in a negative balance sheet condition because they have valued there Collaterized Debt Obligations at an estimate of current market value. Well, it's not necessary. FAS 157 is talking about assets and liabilities you likely would be trading as securities. IF you are keeping an asset to maturity you can use normal accrual accounting rules and all of a sudden your bank is NOT in trouble. If you are not going to be trading an asset or liability but will be keeping it till maturity you are under no compulsion to use market value for that asset or liability.



http://seekingalpha.com/article/125914-mark-to-market-the-bogeyman-of-the-1930s-is-back?source=article_lb_articles

I wonder how many people realize that that FDR got rid of mark-to-market accounting in 1938 after it virtually destroyed the banking sector. According to Brian Wesbury and Robert Stein, mark-to-market accounting was the law of the land for most of the Great Depression until it was outlawed by FDR in 1938. Wesbury and Stein report that the rationale for mark-to-market accounting in the 1930s seems similar to today’s argument for the rule: the need for greater price transparency based upon the efficient markets hypothesis in the banking sector.

FDR rejected the arguments of the efficient markets crowd because he thought that mark-to-market accounting contributed to the Great Depression. For approximately 70 years after FDR’s decision, banks operated without mark-to-market accounting and the economy didn’t have the threat of another depression. Years later Milton Friedman wrote that mark-to-market accounting was responsible for the avoidable failure of many banks in the 1930s. Maybe it is just coincidence, but immediately after mark-to-market accounting was restored in 2007 the banking sector started into a death spiral. Unfortunately, even though history seems to be repeating itself, few people are trying to learn from the past. Even so, today’s Congressional hearings on mark-to-market accounting are hopefully the first step towards stopping this terrible man made economic disaster.

From the Wesbury and Stein article:

….The history seems clear. Mark-to-market accounting existed in the Great Depression…Franklin Roosevelt suspended it in 1938, and between then and 2007 there were no panics or depressions. But when FASB 157, a statement from the Federal Accounting Standards Board, went into effect in 2007, reintroducing mark-to-market accounting, look what happened.

Two things are absolutely essential when fixing financial market problems: time and growth. Time to work things out and growth to make working those things out easier. Mark-to-market accounting takes both of these away.

Because these accounting rules force banks to write off losses before they even happen, we lose time. This happens because markets are forward looking. For example, the price of many securitized mortgage pools is well below their value, based on cash flows. In other words, the market is pricing in more losses than have actually, or may ever, occur. The accounting rules force ("force"? see below_JW) banks to take artificial hits to capital without reference to the actual performance of loans.

One thing to note, banks are not required to use MTM for valuation of assets (loans) if they are planning on keeping the asset till maturity. It's only if they think they will be reselling it that they are supposed to use MTM. So this worry about Zombie Banks (the argument for 'relieving' the banks of their toxic assets) is a bit overdone. If they can't sell the toxic assets then they have to hang on to them. If you're going to hang onto them then you can use accrual accounting. WHich means you use historical value or present value methods for recognizing the value of an asset or liability on your books. OF course, if in the future some loans go into default then you have to write the asset down to recognize that, but at least you are taking the loss when and if it actually occurs.

http://en.wikipedia.org/wiki/Mark-to-market

"For commercial banks and other types of financial services firms, some asset classes are required to be carried at fair value, such as derivatives and marketable equity securities. For other types of assets, such as loan receivables and debt securities, it depends on whether the assets are held for trading (active buying and selling) or for investment.

[Skink]

1. This is what stress testing is all about I guess?

See how banks stand up to actual proven accounting.

[D-Lee]

2. Thanks! Very informative!

Excellent correction of what is commonly thought.

[Ghost Dog]

3. Depends on intention and timescale,

voluntary or forced... Yes, thanks for this clarity.

Let me ponder, overnight.

[JohnWxy]

5. I just think let's use common sense. If you are not going to sell something why not use

Present Value of the payments stream? Naturally, if you think you will sell it, you should look at the market value. But if the Government takes over a bank (to be used as the basis of a public bank which will loan immediately to credit worthy borrowers - individuals or businesses) decide to keep the assets and value them at the PV of the payments stream. If some do go into default okay, then make the appropriate adjustment to the books.

[Ghost Dog]

8. Yes. Having thought it over,

I think that makes sense. Let's support it.

There exist, after all, payment streams, (and demand) however weak, threatened. Although...

[amandabeech]

4. Perhaps everything is wonderful this week because some classes

of trash got reclassified as "loan receivables and debt securities" rather than derivatives.

FASB meets on Monday to consider M to M. They will be under a lot of pressure to loosen the rule more.

[JohnWxy]

6. If your going to classify something as a "debt security" to me that implies that you're holding open

the option to sell and therefor you should use market value.

Even if something is a derivative if you are not plannning on selling it but plan on keeping it and receiving the revenue stream, why book it at market? Re a CDS covering a CDO, if you are planning on keeping the CDO and the CDS is not renogotiable (never heard of any that were) why book it at market, really.

[amandabeech]

7. I understand your point,

but I think that allowing Citi, for example, to make its own determination as to the value of more of its assets will be cold comfort to the market under the current circumstances.

If liquidity is the problem, then loosening M to M may not be the answer, IMHO.

[sendero]

9. Mark to market..

.. is absolutely necessary. In the 30's there was no such thing as a CDO or a CDS. Most of these are worthless now, and they will be worthless in 1, 2, 5 or 10 years in the future.

Without mark to market, banks/IBs/insurance cos will be able to MAKE STUFF UP even more than they already do.


Mark to market is nothing more or less than holding the "free market" bozos to their own rules. If these things had value, or future potential value, it would be reflected in the price.

Mark to market should stay.