Comments on: Why Mark to Market?

By: richard M

richard M — Mon, 15 Dec 2008 12:33:57 +0000

MAS is right about the odious subject of leverage & footnotes, but he's tarred and feathered the wrong target, which is FASB. Maligning Dr. McTeer with allowing "… banks to bury their poor choices in footnotes to make their positions seem more sound" has the ring of a criminal charge. Without advancing a transparent rational alternative asset valuation method, which conceptually is challenge-proof, to replace m2m is about the only fault I can find with Dr. McTeer's postion. In "Mark to Market Frustration", he is winsomely modest in saying he's no expert in accounting, but in so doing, he has misplaced faith in a profession not known for gaining public trust by opening its accepted or recommended practices to challenges by falsification (re. Popper, Karl, on validity test of propositions); like using footnotes when you can't rationally quantify, and acquiescing to leveraging while blind to that two-edged sword. You're hearing this from an once-aspiring mid-level auditor (for 2 years) nearly 60 years back, before he was claimed by a less demanding engineering career, so I have no axe to grind against the accounting profession.

By: richard maher

richard maher — Sat, 13 Dec 2008 10:05:57 +0000

Dr McTeer Tying asset valuation to the vicissitudes of the market makes as much sense as “marking” tonnage, the revenue-generating capacity of cargo-carriers, to flood and ebb tides. Wall Street can stop shooting itself in the foot by dropping accepted accounting practice's “mark to market” approach to asset valuation, and replacing (or at least supplementing) it with a basis that is geared to MSL or some such equivalent measure of change in an asset’s income-generating capacity. The lethal flaw in marking assets to market lies in ignoring the price-history of the asset from which a normal market price P0 could have been projected. Such projection will have accounted for the imprint that past market conditions, including previous boom n’ bust cycles, will have left on P0, but it does not and cannot anticipated current vagaries of either Nature or Man. These unexpected “extraordinary (price) movements” can be graduated at levels of price-range between P and P0 and labeled MSL, for Market Sentiment Levels, where P – P0 = MSL. But, how will this have solved the problem? By way of illustration, let’s assume home prices (by a factor of 10) follow the Dow. A $126,000 home was mortgaged to some bank six months ago when the Dow was 12,594 on 05/28/08 (see PMC_0 at TDN 30 in Chart SMP_2.3_1111 in my website). In normal times, without unanticipated “extraordinary (price) movements” in the market (when Dow would project to 11,146: PMC_0 at TDN 154 in Chart), the house would fetch a market price $111,460 (P), equal to P0 the projected price derived from its expected rental income stream, with MSL (= P – P0) = 0. Unfortunately, since becoming a part of Lehman Bros’ toxic asset heap, the house is now valued at $77,170 (P) on 11/20/08, the day when DJIA projected for 7,717 actually hit bottom at 7,552 (PMC at TDN 154 in Chart). From initially MSL = 0, the house’s MSL rating is now -14 (apprx = 7,717 – 11,146 divided by 248 per MSL step) representing 31% devaluation along with the Dow, yet its income-generating capacity (and real MSL = 0 at TDN 30 & TDN 154) has not changed.

By: Dave

Dave — Wed, 29 Oct 2008 14:20:16 +0000

Mr. McTeer: You’re right on. The misapplication of Mark-to-market valuation (FAS-157) has turned a $300B real estate problem into potentially a $12T mortgage problem by decoupling the security from the underlying assets. I have put together a YouTube video on how this came about: http://tinyurl.com/solve-it. So today we see that the $700B we voted to be used to purchase MBSs is instead being used to purchase controlling interest in banks who in turn are using the money to purchase the banks that have not been so fortunate to be in on the ‘gift’ for pennies on the dollar…when they were supposed to be using the money to create new loans. Ultimately, people will realize that an MBS that is paying a significant amount of interest can’t be worth zero! Then we will do as you suggest and correct the problem and the banks that received the ‘gift’ will have assets that magically appreciate by a factor of 20! If that happens, I hope the American people don’t figure out how they’ve been fleeced. I can think of two reasons for not just rolling back Mark to market to begin with: ego and lawsuits… I suspect mostly the latter.

By: Denny

Denny — Wed, 01 Oct 2008 19:06:05 +0000

Accounting is there to account for the vaulted, internal, financial complexities on a simple public piece of paper. Valuations are all arbitrary and so ruled by accounting rules that everyone in the game accepts. Securities are valued on a financial statement’s as-of date, by same-date public market records. Corporate managers who bought risky securities either didn’t do their homework in terms of the structure and content of these stocks, or they didn’t set up enough reserve-for-loss appropriate to the stock’s risk, or both. Now corporations must take the mark down required by auditors, so the corporation’s public financial statement is accurate to the public valuation of the stock. Embarrassing yet, wrong, no. Corporations can use footnotes to mention the now-off-balance-sheet assets held for later recoveries. The corporation might also mention what it is doing to collect or restore value to these securities, other than dumping on the taxpayer.

By: JuanTwoThree

JuanTwoThree — Wed, 01 Oct 2008 18:00:34 +0000

Those reading this blog, should refer to the many counter-arguments posted in the NYT piece. It seems the average NYT reader can easily poke holes in the failed financial logic of “I know: lets use better blindfolds”.

When we all know assets and liabilities are not marked-to-market is it not logical to reduce our counterparty risk, cash-out investments at the optimistic prices, and hoard cash? How is that a step forward?

I would suggest that markets in all of these instruments be promoted. Sometimes it may be necessary that the FED or Treasury sponsor them directly. It may be scary at first but, after investors have seen they have the option to sell, there is a final buyer, they can get back to comparing risk rewards.

This will help us stop worrying about the return OF our money and back to the return ON our money.

By: Dennis

Dennis — Wed, 01 Oct 2008 16:09:40 +0000

This isn’t a simple issue and ecoshift is correct. As I understand it, CDOs are not simply a portfolio of mortgages but securities that were intended to be traded. A “product” intended to turn illiquid long term assets into short term securities. If they’re offset by short term funding on the books of highly leveraged investment banks and similar holders, there’s a definite mismatch. This is so similar to the ’80s S&L crisis where the newly deregulated thrifts got into businesses they didn’t understand & funded long term loans w/short term deposits. I don’t think Merrill understood what they were buying & probably didn’t understand what they sold at 22 cents on the $

By: MAS

MAS — Wed, 01 Oct 2008 15:46:31 +0000

MWM, let me be your devil’s advocate. The most basic counter argument would be that what is really hurting investor confidence is our inability to trust financial statements. Under the deregulation (Basel II for example) that our country has undergone recently, banks have been able to leverage excessively and hide it. Leverage has an exponenetial effect on the growth (and demise) of a company. High (and hidden) leverage heated the markets fairly well when things were going good, but now that we have hit a downturn, those same policies are starting to hurt. Banks were allowed to hide their poor investments, and because they cannot trust each other’s balance sheets, they refuse to lend money to each other.
Dr. McTeer is advocating a position that allows banks to bury their poor choices in footnotes to make their positions seem more sound. Unfortunately, this will only delay and eventually exacerbate the problem. His plan relies on people to not understand that every bank’s balance sheet is no longer reliable.
Deregulation like this might work in speeding up an economy that is already moving along at a good clip, but using it now in a time of financial uncertainty doesn’t even make sense.

By: Stop Treating Wall Streeters as Villains and Resolve This Crisis - Economix Blog - NYTimes.com

Wed, 01 Oct 2008 13:25:56 +0000

[...] For months, I’ve advocated a simple measure that would make a big difference — the suspension or alteration of mark-to-market accounting rules. My latest effort was an article in Forbes.com reproduced on my blog. [...]

By: ecoshift

ecoshift — Wed, 01 Oct 2008 07:16:22 +0000

re: a footnote explaining the intent to hold to maturity

I’d say marking to maturity should require a commitment, and the wherewithal, to hold to maturity.

If an asset can’t be sold at the value marked on the balance sheet, how can it be used to balance liabilities in the event of a default by the owner of that asset? It can’t. It’s a fictitious value. A balance sheet is a snapshot of your net worth at a given point in time. If your assets are impaired at that point in time your balance sheet become fiction.

By: Rob McMillin

Rob McMillin — Wed, 01 Oct 2008 03:25:36 +0000

MWM — because you’re not listening?