On Mark-to-Market
By Barry Ritholtz - January 4th, 2011, 9:30AM
I love this quote:
“Next time you hear a banker denounce mark-to-market rules, ask if he runs his business that way. Will he offer you a mortgage loan based on what you think your home should be worth, which you can repay only if you make a lot more money than anyone will pay you? If so, then perhaps the bank should be able to use “Alice in Wonderland” accounting on its own books.
Or maybe that is not such a good idea. The banks already tried that, with liars’ loans. Those loans did not work out so well.”
If any of you Mark-to Market defenders care to take a swing at that one, have at it . . .
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January 4th, 2011 at 9:39 am
Who in his/her right mind could defend mark to market accounting?
January 4th, 2011 at 9:43 am
@Mark Wolfinger: Yeah, why even have a market? Just mark
everything to what you think it is worth. Sounds
reasonable.
January 4th, 2011 at 9:45 am
What? Norris IS defending mark-to-market.
January 4th, 2011 at 9:57 am
OT: Thought I’d share this feedback from a sr. software sales guy. Doesn’t seem to jive with lots of happy talk:
“The F500 companies are not planning on spending on any big items, software, infrastructure, people. I have met with at least 20 Sr. people in the last 2 wks at the likes of CITI, Starwood, Apple, Pershing, Fidelity, CapitalOne, GEICO, AMEX, CVS, HP, AT&T, Aetna, Sprint, Unilever & Travelers. They are all in budget lockdown mode. It is insane. These are people that in the past could get a 7 figure deal through. If these guys don’t spend……………………fill in the blanks. (this scares the hell out of me personally.)”
He sells an industry leading software tool for data mining social media sites (really cool stuff) so maybe he’s just in a bad industry segment but he’s always been my canary in the coal mine re: software.
January 4th, 2011 at 9:59 am
Regardless of whatever Floyd is trying to do with his argument, it is broken and sadly inappropriate. Valuation of assets has absolutely NOTHING to do with a contract to borrow money.
Perhaps a better analogy would be if we were allowed to value our homes for insurance purposes at what we think they are worth instead of something approximating an actual market value.
Insurance companies insist on mark-to-market, where their customers’ assets are concerned. It would be insane to do otherwise …
Where mark-to-market breaks down is in the case of thinly-traded or hard-to-value assets, neither of which publicly-owned, FDIC-insured banks should be permitted to own. For busted mortgages in areas where there is no market for housing, there are valuations, but rather than tie the banks down in this area, a simpler approach would be to require banks to dispose of foreclosed properties within 90 days of the foreclosure action.
THAT would fulfill the intent behind mark-to-market, by forcing a conversion to cash. And the banks should be forced to proceed with foreclosures at all due speed, instead of holding the homeowner dangling in the void with interminable foreclosure proceedings. If they can and are going to foreclose, than it ought to happen. If the lender opts not to immediately foreclose, then they should be forced to immediately restructure the loan, with the second restructuring necessitating a reduction in principal owed.
January 4th, 2011 at 10:02 am
Hey, I should not have to mark my six houses in the Vegas suburbs to market, because they are “illiquid” assets for which no financial market really exists :)
January 4th, 2011 at 10:04 am
Always a red cape for me..
here to defend reasonable values, which are often related to WHAT THE STUFF IS SELLING FOR. meaning mark to market. Everyone in favor of markets raise their hand.
But lets not call what we do now “Alice in Wonderland”. “Should be able to use? ”
thats what they DO
why isnt it reality?
its rater regulator pundit academic “reality” the stock analysts and market trade on it somewhat.
welcome to the cheshire cat grin jabberwokky world of financial accounting statements.
“They” (meaning anyone who understands and benefits from lying accounting) plan to keep it that way
the modest FASB Herz proposal now out for comment will die a quiet death now Herz is fired. i give 4/1 on that. any takers?
January 4th, 2011 at 10:08 am
dont know which side of the ying/yang this is .. but I’ll continue the discussion as:
didn’t “liars’ loans” make the world go round and fund at least 1 war? …..
“mark-to-market rules” is what all artists (and others) have to do / or it sits on the shelf becomes obsolete and _?_ (you know) …..
as far as “Alice in Wonderland” / AGGs comment last nite and Hofs pointout to the washing machine history / is what else I found interesting here today
I think banks (and bankers and money pushers) should be on servant salary and loan without interest / because – is it not true that in our present system – its “Private Profits & Public Losses”
but but but / in close’g before submit that Kudlow pitch (you know) “FMCitBPtP” / maybe we are just not bright enough any other way .. awe shucks
January 4th, 2011 at 10:16 am
Try this argument when faced with a margin call.
January 4th, 2011 at 10:20 am
otherT – “software tool for data mining social media sites (really cool stuff)” is that why GS wants FB? more front run power ? dont they see it all now in a flash ? oh ya – a week in in advance would help ?
or is it – to thwart my idea of FB Vote’g – force ideas upon elites ?
or yet is it something else ?
January 4th, 2011 at 10:23 am
If we have mark-to-market accounting, what are securities
worth when the markets are closed?
January 4th, 2011 at 10:28 am
a
primer…..http://en.wikipedia.org/wiki/Mark-to-market_accounting,
including the infamous FAS 157.
January 4th, 2011 at 10:32 am
@JHZumbrum Norris wrote the “next time you hear a banker
denounce mark to market RULES ” (my emphasis), that is, those
parameters and regulations regarding mark to market. He didn’t say
“the next time you hear a banker denounce mark to market” which
would give a totally different meaning the way I read it. Having
said that, the wording isn’t as clear as it should be even if I’m
correct. Norris usually writes very well, so I’ll give him a pass
on that one.
January 4th, 2011 at 10:39 am
I am sorry English is not my mother tongue.
I am a bit confused here.
Sounds like the article’s author is in favor of mtm, right ?
If so, I don’t get the last sentence.
Mtm defenders should be happy with this article, no ?
January 4th, 2011 at 10:40 am
Financial institutions claiming that accurate accounting, admitting what their assets are really worth, would be bad for business, is a sad commentary on today’s business ethics. (I know, those two words go together like “military intelligence”).
January 4th, 2011 at 10:46 am
I was interviewing in Dec 2008 for a senior trading position at a buy side bank. The head of trading made a comment to me, off the cuff, verbatim: “If we had to mark to market we’ d be bankrupt.” My jaw dropped, clearly visibly, and he quickly tried to back pedal, telling me what he meant, how these were temporary impairments, they’d be held to maturity, etc.
Two weeks later, his bank reported earnings and blew up – stock got cut in half. They’ve since recovered, but… Would that have been insider trading, by the way, if I’d shorted the stock? As soon as I saw the earnings announcement I was kicking myself, but still unsure if it would have been legal. I don’t want to get too off topic though…
Anyway, the logic behind SUSPENDING mark to market is that these assets are going to be held to maturity and thus current prices don’t matter. There are some major problems with that. 1) It assumes that everything will be ok at maturity just because, well, WHY? Who is anyone to say that impairments in value are temporary? In my mind, this argument works for very specific assets – like US Treasuries, where default can always be avoided. 2) it assumes that the market is wrong. Now, we all know that markets are not always right, and that markets are not totally efficient, but I like to say that “markets are efficient ENOUGH.”
January 4th, 2011 at 10:49 am
the Red Queen (Shapiro) cries OFF WITH HIS HEAD!!!!!!!!
Herz’s large domelike one
January 4th, 2011 at 10:50 am
If you don’t support M2M, then what do you suggest is the alternative? I buy my home in 2010 for $300,000, and in 2050 I’m supposed to pretend that it is still only worth $300,000? I understand this is not a perfect analogy, but it makes a point. If a bank goes under based on having to M2M down to what might be unusually low asset prices, it should go out. It is not being run in a conservative manner. We need to get back to more reasonable ways of doing business.
On another note and speaking of new ways of doing things… we have been long since 12/1 with our “always-in” 100% long or 100% short strategy. Big changes are coming to this chart list soon, along with a new blog and website. Please vote if you like what you see.
http://stockcharts.com/def/servlet/Favorites.CServlet?obj=ID3274981
January 4th, 2011 at 10:54 am
I guess I have the following points to make on MTM, which are just common sense in my opinion:
1) the market is prone to rather dramatic failures, just when you need the intel the most. So I think we just need to have some form of temporary escape clause for such conditions.
2) If we have MTM for one side of the balance sheet, we need it for the other. It makes no sense to have certain assets being MTM, when the funding behind them is not. This just leads to obviously undesirable distortions in the balance sheet and liquidity levels.
3) Why not make all assets and liabilities MTM, if there is a market for such things? If not, then the corresponding offset on the other side of the balance sheet should also be held static to maturity.
January 4th, 2011 at 10:59 am
Kid – what I have learned thusfar – “possession is 9/10ths of the law & the other tenth is for lawyers to work out in the System”
January 4th, 2011 at 11:00 am
Mark-to-Market is the same as Pro-forma accounting. We banned Pro-forma after Enron. Oh wait, we just changed it to GAAP and non-GAAP. Nothing changes….nothing ever changes. Ad we keep making the the sme dumb fucking mistakes over and over again.
January 4th, 2011 at 11:06 am
it should also be noted that the real problem arising from mark to market accounting was probably the result of excessive leverage which magnified the market price changes to catastrophic levels… if they’d been marked to market, of course…
January 4th, 2011 at 11:12 am
I’ll give it a try. Suspension of mark to market isn’t (or
shouldn’t be) an invitation to lie about the value of your assets.
That is (and would be in all cases) fraud. The idea was that when
there is no market for your asset, you can base the value on some
other metric. In the case of mortgage loans, when the loan was/is
performing, why should a bank be forced to value that asset at
pennies on the dollar simply because the market had dried up and
there were no reasonable bids? The idea would be to write it down
based on the increased likelihood that the loan might go bad at
some point in the future, but not all the way down to a (presumably
broken) market value. Of course, that doesn’t mean some
unscrupulous bankers wouldn’t use this suspension as a reason to
knowingly inflate asset values beyond what might be considered
reasonable, but I think the idea is to not punish every banker for
the misdeeds of the dishonest ones. We’ll get our chances at them
as their banks blow up and we can (hopefully) throw them in the
clink for fraud.
January 4th, 2011 at 11:36 am
There’s mark to market the concept, a separate debate and
there’s mark to market in “fast market” conditions. In some
respects it is akin to the valuations during the Flash Crash,
http://en.wikipedia.org/wiki/2010_Dow_Jones_Flash_Crash Were the
prices of stocks previously trading for $40 now trading at pennies
accurate at that point in price and time? The buyers certainly
thought so but the exchanges did not and the trades were cancelled.
FAS 157 got a bad name because it came along in September 2006 when
the housing market/derivatives were already in a post bubble
environment unbeknown to the public at the time. Had 157 been
written earlier as was the original GAAP/mark to market in the
early 90′s we probably would not even be talking about it. As such
it became a useful symbol of the last straw such that it’s
suspension has been mentioned as an element of the market’s ongoing
recovery from March 09. ….”On March 9, 2009, In remarks made in
the Council on Foreign Relations in Washington, Federal Reserve
Chairman Ben Bernanke said, “We should review regulatory policies
and accounting rules to ensure that they do not induce excessive
(swings in the financial system and economy)”. Although he doesn’t
support the full suspension of basic proposition of Mark to Market
principles, he is open to improving it and provide “guidance” on
reasonable ways to value assets to reduce their pro- cyclical
effects.[18] On March 16, 2009, FASB proposed allowing companies to
use more leeway in valuing their assets under “mark-to-market”
accounting, a move that could ease balance-sheet pressures many
companies say they are feeling during the economic crisis. On April
2, 2009, after a 15-day public comment period, FASB eased the
mark-to-market rules. Financial institutions are still required by
the rules to mark transactions to market prices but more so in a
steady market and less so when the market is inactive. To
proponents of the rules, this removes the unnecessary “positive
feedback loop” that can result in a deeply weakened economy.[19] On
April 9, 2009, FASB issued the official update to FAS 157[20] that
eases the mark-to-market rules when the market is unsteady or
inactive. Early adopters were allowed to apply the ruling as of
March 15, 2009, and the rest as of June 15, 2009. It was
anticipated that these changes could significantly boost banks’
statements of earnings and allow them to defer reporting
losses.[21] The changes, however, affected accounting standards
applicable to a broad range of derivatives, not just banks holding
mortgage-backed securities.
January 4th, 2011 at 12:02 pm
I think, maybe, Barry meant to write ‘detractors’ rather than ‘defenders’.
January 4th, 2011 at 12:12 pm
@Lukey: “why should a bank be forced to value that asset at pennies on the dollar simply because the market had dried up and there were no reasonable bids?”
because that’s what you can sell it for! It doesn’t matter what you THINK it’s worth – if you need to sell it, this is what it’s worth! of course, problems arise from that.. .because once you mark it to market price, that can trigger the NEED to sell it, and a negative feedback loop, which is precisely why the abandoned MtM, I think.
January 4th, 2011 at 12:40 pm
Ask the GOP if they’ve read their legislative bills, will take a pay cut, or will provide their birth certificate.
January 4th, 2011 at 2:23 pm
I wonder how many traders got margin calls in March of 2009 from the same banks that were screaming “repeal MTM, or there will be armageddon!”
What’s good for the bank (since The Supreme Court declared corporations as equal to citizens) should be good for the rest of us?
The next time BofA/Merrill or GS, or C sends you a margin call, tell them that you will hold assets “to maturity”, and they’re not valuing it correctly.
Imagine a 10-times over bankrupt BofA/Merrill or C force-liquidating your positions based on the MTM value one day before MTM was “repealed”, banks themselves were “saved” and the market started 85% run? Wouldn’t you be p***ed-off?
January 4th, 2011 at 2:24 pm
@KidDynamite “because that’s what you can sell it for! It
doesn’t matter what you THINK it’s worth” But you aren’t being
forced to sell it. You may well be intending to hold it throughout
the amortization schedule. You are valuing your assets at what they
are worth to YOU – not Mr. Market. And the problem, as you alluded
to, is that forcing you to value your assets at less than they are
worth (to you) forces your capitalization ratio down which drives
down the value of your stock which may force you to have to sell
these assets at the depressed price to raise capital or sell the
stock at an artificially depressed price to another bank with less
exposure to the damaged market. Why we would want to risk these
kinds of forced liquidations of ostensibly adequately capitalized
banks makes no sense to me. I understand the logic behind mtm and I
think it makes sense in many industries (especially where assets
don’t self liquidate like autos or steel). But with banking I think
it (potentially) does more harm than good.
January 4th, 2011 at 2:42 pm
Any bets as to what happens to mark to market suspension
when the assets appreciate to a positive equity value ?
January 4th, 2011 at 2:55 pm
@b_thunder – obviously, you’re being cute, but I hope you understand that suspending MTM doesn’t apply to equity positions at BAC/MER/GS/C, just like it doesn’t apply to your own account…
I do like the idea though – “we’re holding it to maturity.”
My former trading desk actually had problems like this in 2007 – we did a lot of Merger Arb, and lots of deals saw their spreads widen. Management would say “hey – you guys better cut this position,” and we’d say “nahhh – the losses are temporary – the spreads will tighten again and then the deals will close.” essentially: WE”RE HOLDING IT TO MATURITY – even for an equity position… Of course, we still had to report the losses as they happened, this was just risk-management justification.
Most importantly, sometimes we were right about the spreads coming back and the deals closing as expected, and sometimes we were wrong! that’s the problem – even if you have the ability to hold it to maturity, that doesn’t mean it’s money good!
January 4th, 2011 at 3:20 pm
@diogeron
There could, of course, be someone who supports a concept but is concerned about the particular rules and thus the distinction could be important in that sort of situation. Norris, however, is really pretty clearly defending both. I think the explanation that Barry meant to write “detractors” makes the most sense, although I’ve been puzzling about it all day, even looking up the idiom “take a swing at” to see if I’d misunderstood it all these year; I hadn’t.
January 4th, 2011 at 3:21 pm
think for a moment about how much your house is worth.
now consider how much your house is worth if you have to sell it in the next hour.
January 4th, 2011 at 4:39 pm
M-T-M is awful. Really a key cause of the crisis.
The writer above is defending mark-to-market and making a bad (really ignorant, low IQ) analogy.
The right analogy for home mortgages is — you buy house for $1m, with $200k down. You make payments. Bank comes to you and says… “since your house declined in value to $800k you need to put another $160k down”. Either you “m-t-m” or you are bankrupt.
This is stupid. All the payments were being made (like most bonds throughout 2008/09).
This is what regulators — Sheila Bair, Paulson, Bernanke, etc… did to the banks. It was tragic and stupid, and with AIG/Lehman and subprime because a cascading cycle. Oh, then high-yield went up 300% and mortgage credit bonds went up 300% once MTM was suspended. All the cash-flows were fine. Some bonds and REIT equities went up 2000% or more!
Turns out the “mark-to-market” was just a license for speculators to front-run silly old institutions with bad regulators. Nice work!
BR – You pitch alot of “M-T-M” and whine about “TBTF” instead of focusing on bad regulators forcing bankruptcy in the midst of a worldwide crisis. Good regulation is about prudence BEFORE the crisis.
January 4th, 2011 at 4:58 pm
I read some good arguments on both sides.
Seems like institutions should have to pick a regime, MTM or no MTM and live with the consequences.
I’m also thinking maybe banks should have a right to demand more security on mortgages where underlying home value has declined significantly. Ought to help tamp down speculation.
BTW that last comment only applies to other peoples mortgages, not mine. I chose “no MTM”. Doing that to me would be unconscionable.
January 4th, 2011 at 5:47 pm
@cognos – housing is a really bad analogy for mark to market, as the market value of your house (Variable) bears no relevance to the payment due on your mortgage (fixed at the time of purchase). In fact, I believe that a more accurate housing analogy would be that you buy your house for $1mm with 200k down, you make your payments, but then the market crashes, the economy crashes, you lose your job, and everyone knows that you will not be able to CONTINUE making your payments.. The value of your outstanding mortgage goes down – it doesn’t stay the same – in all likelihood. So when the bank goes to sell your mortgage paper to someone else, it’s not worth the full $800k anymore. That’s all.
An even better “housing” analogy would be that you buy 10 houses, each with the minimum % down, and needed to rely on cash-out re-fi’s in order to be able to pay the mortgages. Once home prices stopped appreciating, you were dead. That’s really what the banks did with leverage.
It wasn’t mark-to-market that killed the banks – it was their leverage, combined with that cascading cycle of mark-sell-mark lower – sell more….
January 4th, 2011 at 7:59 pm
KidDynamite – NO! PLEASE. 100% WRONG.
Many if not MOST of the bonds “marked” to 5, 10, and 50 pts out of 100… they ALL MADE ALL THE PAYMENTS! The cash flows were all fine, always (which is why they are now UP in price by 300% to 2000% since the nadir of the crisis).
What about this dont you understand?
January 4th, 2011 at 8:14 pm
1. Isn’t M to M accounting during ascent portion of the Housing bubble and FIRE Stock evaluation?
2. M to M accounting brings the balance between the perceived VALUE of the ASSET and the expected PRICE to be bought or sold in a time frame. Value (intrinsic) remains the same but the price fluctuates. Do you want one standard of accounting while buying and another while selling or vice versa?
Banksters ended with the cake and eating it too!
It appears Lender has one standard ( M to fantasy) but the borrower/home owner applying HEQ loan has another standard ( M to M) Is this fair? The value of my house 2 M in Jan of ’06, went down to 1 M on Jan of 2009 but the MBS security containing that loan still has market value of 2 M and not 1 M, since Banks evaluate them on M to Model/Fantasy standard. Wow!
January 4th, 2011 at 8:56 pm
anyone who disagrees with MTM clearly has never been on a margin call…you know what you need? MORE cash or get the fuck out…this ain’t rocket science kids…
it doesn’t mean a damn thing if you are correct tomorrow, next week or in 20 years…it is what it is…
this cute little tool that causes a few problems is called EXCESS LEVERAGE!
It is truly hard to believe anyone reading this blog can’t figure that out…
January 4th, 2011 at 9:00 pm
M2M matters when you’re levered AND when you don’t have term financing matching assets & liabilities. That was the problem with banks. They were effectively arbitraging accounting rules with carry trades, duration extension, and increasingly risky credit profiles. However, the accounting changes were not helpful b/c of the timing. If m2m had been in place prior to 2003-2007, the pain wouldn’t have been as severe b/c banks would have altered their behavior. And….that would not have been such a bad thing.
I can go both ways on this issue, but bottom line is the system is probably better off when levered institutions with non-deposit and non-term funding have to mark to market. It would keep their balance sheets smaller, which is EXACTLY why they fought the issue for years before the 2007 meltdown.
January 5th, 2011 at 12:00 am
I very much agree with Bobby’s 8:56pm comment.
@Lukey – sorry, I didn’t see your reply earlier. You wrote: “But you aren’t being forced to sell it. You may well be intending to hold it throughout the amortization schedule. You are valuing your assets at what theyare worth to YOU – not Mr. Market. ” That’s only true if you’re not overlevered. If you’re overlevered, you pay the price. You lose some discretion. See Bobby’s comment!
@Cognos: They made the payments, largely as a result of (unprecedented, massive) intervention! But that’s not the point. The point is that the fact that you haven’t defaulted yet doesn’t mean that you won’t default. See: the MBS market, 2007-2008! NO ONE is forced to sell positions because of mark to market unless they’ve overlevered themselves, just like no one who wants to hold an equity position gets a margin call when they don’t buy on leverage. When you play with other people’s money, you lose some discretion as to your position management. We have these rules for the sake of the system.
Now, yes, of course, I understand the negative feedback loop, and the problems associated with it, as I”ve already mentioned more than once above. But when you NEED to sell, it doesn’t matter what you want to sell for, it matters what someone will pay.
there’s an old saying… “sell when you can, not when you have to”
it’s really hard to convince a trader that Mark to Market is somehow unfair, unjust, or bad in general. If you don’t like being forced to liquidate, DON”T USE SO MUCH LEVERAGE
January 5th, 2011 at 8:31 am
My response to those who point out it’s like a margin call is who is it a margin call from? It appears to me to be from regulators (not a good idea IMO). As for the effect of leverage, MTM in a downward cascading market increases your leverage as the MTM value of your assets declines, even if they are performing. That seems to me to be a sub-optimal outcome, as it could force you to liquidate your positions when the market for them is not functioning. I’m not suggesting you shouldn’t have to mark your assets down in these situations. As the housing market became unstable, it obviously impacted the value of the mortgage holdings of banks (and they would be obligated to write them down to reflect the compromised nature of the underlying real estate). But if the loan is performing, I think that should be a reason they could use to not be forced to write the asset down all the way to the market level (a market that, for all intents and purposes, no longer existed).
The investors on the hook in this situation are the bank’s stock holders and bond holders. Would they be inclined to make a margin call? The stock holders certainly have no incentive to have their assets liquidated at (artificially) deflated prices and the bond holders (provided the bank isn’t violating any bond covenants) have the option of dumping their bonds if they think the end game is bankruptcy (a remedy also available to the stock holders btw) or holding the bonds to maturity to recoup their investment.
I think the thing we want to avoid is forcing banks to write down their assets, thereby compromising their stock value which results in them having to raise capital by selling stock (or assets) at depressed prices, which then results in permanent losses to the stock holders from an (ostensibly) temporary impairment of asset prices.