Actually, I am/was a CPA but that’s a separate story.
“Mark to market” is a term that few if any, outside of the financial or accounting industries had heard prior to mid last year. Now, most people have heard the term and know that it is somehow related to the problem of the subprime market.
In short, “mark to market” means that financial institutions need to recognize the market value of their investments as they change rather than waiting until they dispose of the asset and recognizing a gain or loss. The purpose for “mark to market” is to reflect the estimated “value” change of the asset real time rather than having shareholders or mutual fund holders get surprised (up or down) in one fell swoop.
Numerous articles have been written suggesting that mark to market while not causing, greatly exaggerated the subprime issues. The argument, one that I support, is that when the ability to sell what used to be “marketable securities” i.e. the bundled subprime mortgages, dried up and the only way to sell one of these was through a forced or coerced sale, the value of these bonds was set artificially and unrealistically low. The result was that financial institutions holding these bonds were required to write their values down to a “market value” which was substantially less than what the reasonably expected value of the loans were.
By way of an example, imagine you owned a car that had a fair market value of $15,000. Now, imagine that you found yourself in a financial bind and needed $7,500 immediately. You are unable to borrow money, you have no money in savings to draw on. The only way to get the money you need is to sell some assets. Because the buyer knows you’re desperate for cash, they low ball an offer on your car and because you desperately need cash, you agree to sell your $15,000 car for $7,500. In the financial world, the fact that you only got $7,500 for your car, regardless of the circumstances, meant that all cars like it now got marked to a market price of $7,500. Never mind that your sale was “forced” or that it was reasonable to assume that other similar cars could sell for $15,000.
The above situation, while a much simplified version, is exactly what was happening to the subprime loans. Yes, there was concern about defaults that would take some of the value out but, as I pointed out here, the NYfed thinks the actual loss after default, could be significantly less than any of the numbers being arbitrarily floated.
The Fed has finally issued a clarification that explains that “mark to market” should discount circumstances where securities are transacted via a “fire sale.” Admittedly this adds some ambiguity to the process. Even so, this seems to make a lot of sense. While investors and regulators would like conservatism in estimates they also know that numbers that aren’t “real” provide little value.
Over the next few days you’re likely to see and hear comments like this about the Fed’s clarification:
The language is technical, but the arguments here are simple and really quite silly"”especially coming from folks who value market indicators over all else. These folks are saying that when markets are volatile and irrationally pessimistic, it’s just not fair to force people to act as if the market prices are real.
Remember that that isn’t what the Fed is saying. The rules have always been meant to estimate the”fair value” of the security. According to the group who promulgates accounting rules, FASB, “Fair Value” is
the price in an orderly transaction between market participants to sell the asset or transfer the liability in the market in which the reporting entity would transact for the asset or liability, that is, the principal or most advantageous market for the asset or liability.
(emphasis mine)
My point is that while critics will try to point to the Fed’s clarification as more “corporate bailout” (and further justification for the “main street bailout” of home mortgages), the Fed is only pointing out language that has always been a part of the definition but, because we’ve never seen such a fast melt down of a specific asset class before, had not been fully thought through and applied.
Based on what I’ve seen since the Bear Stearns transaction, I’m willing to give the Fed the benefit of the doubt. These are unusual times. Correcting and adjusting will continue and should be expected. It doesn’t mean that the Fed is trying to pull a fast one on us.
Well, yah, but:
The other side of that argument is as follows:
IF the $30Bn in securities is “market-priced” and IF the bundle includes ‘a large amount of Gov’t-Agency-Backed’ packages, and the Fed does NOT expect them to deteriorate in value….
Then WHY the Fed’s intervention? Why didn’t JPMorganChase simply take that package as part of the deal, IF it’s got all those positive attributes?
After all, in 10 years (the term of the deal) the package’s payments will be fine and dandy, no?
The Fed can massage the text as much as they want. Fact is, JPM/Chase did NOT buy the $30Bn in securities for a reason. Maybe “market,” no matter WHEN it was valued, was not the same as “real” value.
Dad29, I agree with the underlying concern you have. However, I think the situation is a bit more nuanced/complex/name your favorite adjective, than what has been in most press accounts. From JP’s side, I think the issue may have been that they didn’t want to saddle them selves with assets that could put them right back into the same spot as B/S was i.e. the $30B asset, because of continuing “fire sales” and the Mark to market requirement, suddenly gets “written down” to 1/2 that. That could have serious reprecusions on their equity and ability to do business. JP was one of the few investment banks that saw the subprime issue early and got out of the business so with the Fed basically asking them “for a favor”, they were in a pretty good position to negotiate. Everyone I’ve read who looks at this practically rather than from a political agenda believes that JP got an amazing deal…this further convinces me that the Fed felt they HAD to do something and did what the needed to.
I can’t read the Fed’s mind but I suspect the issue was that they “needed” to get the B/S deal done. Because they felt it was so significant, they were willing to do extraordinary things. I guess the “proof will be in the pudding.”
The guy I’ve been reading who has the best insight on the topic is here: http://www.redstate.com/stories/economy/more_on_the_federal_reserves_st_patricks_day_massacre
He’s been pretty accurate on his read of the B/S situation and appears to have contacts with some direct knowledge of the deal. His evolving assessment is that the NYFed believes that there is far more upside opportunity with minimal downside risk to the “assets” they bought.
Net is, I haven’t “drunk the kool-aid” but I think the constant “gotcha” from folks who either have an agenda or just don’t want to understand 1. how close we came to a serious meltdown or 2. the fact that the entire financial system is in uncharted waters and the “answers” or “soltutions” are fluid, are disingenuous and should be called on it.
Thanks for reading and posting…I appreciate your pushing the thought process.
We read the same guy on the situation.
Clearly, there are two camps: the “sky is falling” bunch, and the somewhat more long-view types who grant that there are serious problems, but nothing calling for a Fed takeover of everything mortgage-related.
OTOH, there will be more bank-casualties, and soon.
Reported discount window borrowing last WEEK was over $10B–an unusually large number.