I really should send an e-mail to my godfather and cousin, who is a CPA, but I have to wonder what the conservatives rage against this sort of accounting is. I can understand their opposition to a number of policies, even if I disagree with them, but this seems like they are angry that MTM accounting allows for a greater degree of negative reality to set in. If that's the case, why? I don't see how this can be the reason that any sort of securities are viewed less positively than they should be, so unless they have some proof of that, are they just upset at calling a spade a spade?

And if they are full of it about this, does that make three concepts which really aren't responsible for most of the problems? The first is Fannie and Freddie, which didn't cause most of the problems and the second is the Community Reinvestment Act.

Oh yeah, has anyone here seen any conservatives blaming some 1997 tax bill signed by President Clinton that put in a $500,000 deduction and some other changes for allegedly contributing to the real estate boom? I have, but I am not sure what to make of it.

I firmly believe this is a sleight of hand - to artificially pump up the value of those toxic assets the bailout bill will authorize the Treasury to buy.
Rememeber - no one really knows WHAT PRICE is going to be paid for the assets? $.02 on the dollar? $.22? $.75? This is the real shell game going on. Even though Bush stated in one of his "boogeyman politics" addresses recently that the Treasury will buy these assets at fire sale prices - and the taxpayers will make a bunch of money on it later. I don't believe a bit of it - especially now. The big shitpile of dreck suddenly got a lot more expensive to clean up...

Sorry, don't know the answer to your question.

Regarding M2M itself, we only need to ask ourselves one question: Did financial companies have a problem with M2M when their paper was valued much, much higher than what it is today?

The more shenanigans the SEC/Fed/Treasury pull out of their asses, our financial institutions become less transparent and trustworthy. Playing accounting games covers up the truth for a few weeks, but then we will back to facing reality. This is what has already happened since the Fed started addressing this crisis over a year ago. Things got lot worse and the Fed/Treasury have less credibility and ability to handle the crisis. They should have taken a tougher approach up front and forced financial companies to acknowledge problems and raise cash.

Only about 15% of bank assets have to be M2M'd. The Available for Sale portion of the investments. See the data on the FDIC's website.

Of the 15% only about 8% might be MBS/CMO/CDO stuff.

And all the MBS are not worthless. A lot of the underlying mortgages have PMI or are GNMA & FNMA insured.

So it shouldn't be that big a deal.

Mark Thoma has a good post on M2M valuation today, but not one that answers your question.

I actually have another question though: the nice thing about M2M valuation rules is that everyone is obliged to calculate value in the same way -- market price -- since they are all in the same market. I don't see how the rule change requires consistency in different outfits' valuation of their assets. Am I missing something?

My father, who was a comptroller of a bank-like entity prior to retiring, suggests that for assets that did not have a market (like unlisted equities) they used a 'present value' measure, derived from 'future cash flows' like interest and dividends. This would certainly allow for uniformity across institutions, but I don't know how it applies to the CDOs (because I can't really understand how the CDOs work -- or were supposed to work -- and don't know how you'd factor in foreclosures to the expected interest return, say).
Kind of makes me want to be an accountant, actually.

Regarding evaluating distressed mortgages,it would seem to me that one way to set their minimum worth is to value them at the price it would take to rebuild the building (i.e. like "replacement" house insurance does in the event of a fire). I know that this keeps out the value of the actual land, but it is the latter that goes up and down like a yoyo, in real estate bubbles. It's not perfect but it is a start.

Actually, I think it's pretty simple--esp. since I saw one of the Republican congressional advocates interviewed by Rachel Maddow lat night. The Right sees this as a quick fix that will solve the problem without the threat of "socialism" or any huge expenditures. I'm not sure, though, that they quite understand it. I'd swear that I heard the guy claim that modifying the mark-to-market rule would allow the banks to, er, mark to market! I think they're getting their catchphrases confused.

Why? Maybe because they weren't getting anywhere blaming Sarbanes-Oxley for the economic/financial problems? Most folks can understand S-O because it's pretty simple, but M2M is harder to explain and easier to intimidate people with.

That'd be my guess.

Of course, the fact that these people's brains are hooked up crosswise is the main reason.

If volatility is the problem with M2M, then some sort of moving average could be applied (like they should do for non-core CPI factors like food and energy).

Good question, Kevin.

I just assumed it's because right wingers reflexively come down on the side of money and power.

Andrew Leonard has a post about M2M in Salon today that attempts to answer the same question:

http://tinyurl.com/3u7jux

Too complicated for me to recap. But he points out that liberal Democrat Peter Fazio (OR) has an alternative plan that suspends M2M, so it isn't just the Republicans who support it.

Drum: Why have movement conservatives suddenly made a fetish out of M2M?

Because we have a republican president.

I think "cooking the books" maybe considered a first amendment thing.

I can see where M2M is a bad thing in panics (and booms, too). If you get an irrational trend going, it amplifies it, and that's not good.

However, it's hard to see how a hard-over free-market sort could not like M2M -- whatever the invisible hand writes, that's the truth, right?

M2M - If you are going to change Mark-to-Market rules for banks, why not change the rules for the property owners? If the banks can keep the original values on their books, give the same deal to homeowners and the problem of values goes away for everyone. This would cost the tax-payers nothing and protect Main Street and Wall Street as far as the values are concerned.

This site has gotten too, too arcane. Bye.

As to the instant question, I think quaker in a basement is right. Don't count on the wingnuts for financial sophistication, or even the patience to listen to an explanation. A lot of that movement lives to hate, nothing more, and if M2M can be portrayed as an "attack on Freedom" or something, that's good enough.

And to tell you the truth, I don't worry about what upsets the wingnuts anymore. Yes, they have a powerful media voice and a responsive community, and so they also have responsive political servants. But it's not clear that's reason to worry about what upsets them.

Look at it this way: the weather is also powerful, and it's worth paying attention to, but it's not worth worrying about in terms of cause-and-effect. It is what it is, and it's random. I think the same way about the wingnuts. Who knows what's going to take hold of their tiny, angry brains, and send them screaming into the streets, or onto Redstate or somewhere, veins bulging and bibles waving? Who knows what sends tribes of monkeys on raids into jungle encampments, or rivers of army ants into villages and towns?

They are not rational. They need not be considered rationally.

In a severe down trending market like this one, banks probably need to inflate assets used as collateral against the loans they need to operate day-to-day. When the value of the assets go down, so does the borrowing power of the bank. The M2M rules effectively hand cuff their ability to take an optimistic look at value.

Just a guess.

Why mark to market? Follow the money. Always. In politics.

Welcome to the craven new world of Gekkogate.

It's pretty simple. M2M is making things look bad, and this threatens our chances of getting elected.

Plus, this isn't a real crisis! I got two credit card offers in the mail today, so credit isn't scarce! Plus the Dow went up yesterday, so clearly Paulson and Bernanke didn't know what they were talking about.

First they come for the short sellers, and I was not a short seller. Then they came for mark-to-market...

One important reason to keep M2M is that suspending M2M may lead to less confidence in banks. Currently banks are spooked because they don't know which of their brethren are insolvent. If they don't have to mark-to-market problem assets then this lack of confidence becomes even more extreme. Thus suspending M2M may lead to increased, rather than decreased, financial problems.

"As to the instant question, I think quaker in a basement is right."

Sweet, sweet music!

This will be weird, but hang on: To the extent that they actually understand what the change means, I think it's because they really believe that everything has a fundamental intrinsic value and that M2M is a shady way to rig prices so somebody makes money who doesn't deserve it.

Of course this plainly violates everything they say about the sanctity of the market. So how does that work?

Well, they believe the market really is from God, and they believe the Bible is the word of God, and the Bible is eternal and unchanging so the market really, when you get down to it, is the word of God, which we know is eternal and unchanging.

The market, which mystically knows the true value of everything, must therefore actually be stable. But it's obviously not, so it must at least reflect God's moment-to-moment judgment of the value of things.

But that's the *true* market. And the true market is about real tangible things. Oil, gas, land, and stuff are all tangible; no problem with price changes there.

Securities, though, can be rigged and manipulated easily because they're only man-made paper, so the only way you should value them is by looking at the real true value of the real true things they're connected to. Never mind what somebody will pay for them, because they aren't real market goods.

So it's really theology at work here, and it's about what is tangible and real and what isn't. Remember that populists have always distrusted banks and paper as the work of Satan.

And what it really means is that underneath it all they believe in a "just price" system, but they've been taught by the moneybags of the party to call it "the market."

Suspending M2M may indeed be nuts, depending on the precise meaning of "suspension." I've not read that section of the bill so I'm not sure of the precise definition of suspension. However, M2M actually has three parts. The first is where there's an active market. Then the valuation is pretty simple. If there's not an active market, then the institution must use a model and that model needs to be justified. You can't just pull assumptions out of your ___ and come up with any number you want. There are a bundle of accepted models and one can quibble with the underlying assumptions, but there is a process and bank regulators know the game well.

If this suspension of M2M is just dropping the first requirement and moving to the second, e.g. because markets are thin, then it's not really eliminating M2M; it would be using a different method. Not ideal perhaps but not entirely problematic.

If this suspension means something different, then I would argue that there is a very real problem. In particular, the marketability of bank stocks would go straight to zero. You simply couldn't trust a bank's balance sheet. M2M is in place to protect investors - Main Street if you want to phrase it that way. Without M2M, a bank's balance sheet would have very little meaning.

Why is M2M suddenly a hot issue? My guess is that it's one regulatory component that Republicans have seized on as potentially causing the financial crisis, much like a few days back they were all over CRA, again a regulation, for causing the crisis. Their critic of CRA was totally without merit; same with M2M.

Wachovia went out with a book value of $75 billion. Citi paid $2 billion. Could it be that asset values are overstated, not understated?

-Michael Rapoport, Dow Jones

Enough said.

It's very simple. No M2M = less transparency, which will obviously give everyone more confidence in our financial institutions. (At least that's the answer I got with my magic 8-ball.)

Am I just being dumb, or are they trying to solve a liquidity problem by injecting uncertainty?

Because it has the scent of an easy fix about it, nobody needs to understand much about that economics stuff, it takes away some of the influence of the technocrats (if there's anything the wingnuts hate as much as a liberal it's an educated expert with some authority), and the financial industry lobbyists have been pushing for it, off and on, forever, and now they can use this crisis to get it. A better question is why this didn't happen months ago. To the extent that the shit hadn't already hit the fan, it would have had a bigger effect then; now it's meaningless, as everyone has an idea of the true value of the assets, whatever their book value, and nobody wants to pay much for them.

Is a wrecked car worth any more because the claims examiner hasn't examined it yet, when all the potential buyers know the car has been in a wreck?

How about another way:

There can't be a problem if we say there isn't one.

The stock in that box is root(2)/2 alive and root(2)/2 dead.

M2M is a premature wave function collapse.

I applaud our Republican colleagues (and Pete DeFazio) for striving to ensure our accounting procedures follow the laws of quantum mechanics.

M2M's problem for our economy is that it accelerates volatility without enhancing transparency.
It is true that some "products" have an insufficient market to provide a credible price.
It is also true that allowing companies or banks to price their own products is an invitation to fraud and book-cooking.
A reasonable solution is to retain M2M but extend its time horizon--not daily, not weekly, not even monthly--but perhaps quarterly.
This reduces the volatility inherent in the stock market and inserts instead the cold-eyed assessment of the real marketplace

http://krugman.blogs.nytimes.com/2008/10/01/stockholm-syndrome/

Link goes to some minor no one who isn't so thrilled with the bailout bill.

http://marketplace.publicradio.org/episodes/show_rundown.php?show_id=14

MarketPlace talks to Peter DeFazio about why he thinks the bill is bad, and Bernie Sanders who explains some of his views.

Hello. I am a CPA and here's my two cents:

First, I don't believe that M2M rules actually forced companies to revalue all of their assets. (Something "BS" alluded to in his comment). In fact, I believe it gave them the option to revalue them. And even then, I don't think they were forced to do this across the board (or across the balance sheet in this case), just selected holdings/asset types.

I'm not 100% on these thoughts, as Financial Accounting is not something I specialize in, but that's what I've gathered from reading various accounting publications and attending Continuing Education class.

I remember wondering how this could possibly provide any Consistency, which is one of accounting's basic principles.

In any event, I think you can see why it may have contributed to the situation. I suppose the line of thinking is "If we're allowed to revalue these assets at cost basis, as we always did in the past, our balance sheet improves" Again, it's a way to improve the balance sheets without taxpayer's money.

Now, whether getting rid of these rules now would actually have a positive impact or a an impact similar to what you outlined ("blacklisted" companies, so to speak), I don't know. Off the top of my head, I would tend to side with your prediction, in which case, that may be why not many Dems are calling for it (i.e., they think it may do more harm than good).

That said, I wouldn't mind getting more info from both sides as to why they'd be for or against this.

Here's a great source for answers to most of our questions. Instead of me rambling on unintelligibly, go listen to this audio

HERE

of a Princeton economics forum on the financial crisis with Paul Krugman and four other Princeton faculty giving ten-minute talks on the micro- and macro- issues, as well as an historical timeline and a 'what to do next' discussion. It's an hour and five minutes long. Krugman begins at around the 45 min mark if you want to skip the esoteric stuff. Excellent (and understandable) discussion, plus Krugman was funny.

Krugman says, re this discussion on MtoM, that the only possible way the government can bail out the banks is by paying face value for the toxic stuff. Paying fire-sale prices won't help at all and he has graphs of assets/liabilities/sludge to make his point. He says that taxpayers deserve an equity stake in the banks that are bailed. And it won't be a 'sliver.' He also says that time should be taken to do it right. Is the Senate voting right NOW???

http://www.clusterstock.com/2008/10/warren-buffett-why-i-bought-ge-why-we-have-terrible-terrible-problems-

Warren Buffett on why the bill could be a good idea, and should be a good thing, but how Paulson could likely turn it into a very bad thing.

The More You Know.

I haven't thought about this issue, but just reading these comments it occurs to me that there may be a traditional argument they're flipping on it's head because the situation has flipped.

What I mean is, normally they argue that an employer who is "buying" labor from a person can bid the price down because they can do without those services and they have flexibility. It's a buyer's market. To ensure that, as they argued in the 1990s, it's good to keep part of the workforce unemployed, about 6%, so working people won't get 'uppity' and ask for raises since they'll always know they could quickly be replaced (presumably by homeless uneducated people).

However, in the current crisis there are firms who have assets which nobody wants to buy and that's upsetting. It's usually the rich who have flexibility, but here there are some Rich people are in trouble. They depend upon a few other Rich people. But, they're only offering low dollar (mark-to-market).

What we see is the hugely awkward situation of a Rich firm having to deal with life the way 99% of us do every day of our lives. We get low dollar for our day's work and now there's some possibility they might too.

In a market life's great when there are plenty of buyers, but it's a crashing bore when there are only vultures who know you're on the ropes and they would be happy to take your dollars for pennies. Life's tough when you're no longer a master of the universe.

Jerry,

It looks like Buffet disagrees with Krugman then about buying at market prices. Market prices would be something like 20 cents on the dollar, right? Interesting. (Unless I misunderstood Krugman, but I don't think I did).

I think there is a legitimate issue here, arising from secondary and tertiary effects.
Let's say you are desperate for cash and sell a CDO for 22 cents on the dollar. There were some defaults in the underlying mortgages, but nothing like three quarters of them,but the market doesn't really understand the paper and that's the best price you can get. Now suppose I own a piece of the same issue, which I intend to hold to maturity and collect cash flows that currently appear to have a present value of say 50 cents. I now have to mark it down to 22 cents. This reduces my capital. And maybe the analysts or rating agencies downgrade me because my capital ratio has gone down. So maybe I have to sell something now to reduce my leverage. Maybe I sell a better asset at a discount in order to do this, driving its price down.
I think this is part of the problem, and the rightwingers have seized on eliminating M2M to fix it. I don't agree, but I'm not sure what the answer is. Maybe part of it is to keep M2M but temporarily relax the regulatory capital hit arising from it, on the assumption that the market will return to something closer to the "real" value of the paper's cash flows. And maybe if and when Paulson starts buying this stuff he buys it at current fire sale price but also gives the seller a piece of tradeable paper worth a portion of the eventual upside if any occurs. Presumably a market develops for these certificates. This might "bridge" the gap between the current distressed prices and the likely higher long run value for at least some of this crap.

Kevin, I'll try to explain the objection to mark-to-market as I understand it, with the caveat that, although I work in a bank, I'm the IT manager and don't know that much about finance. But my CFO does, and he's not a fan of M2M. His reason is that it's his job to manage the bank's balance sheet, and M2M introduces unwelcome volatility. And this is a guy who, when offered CDOs (mortgage-backed securities), declined to purchase any because, as he says, "I couldn't figure out how to value them." He's a smart, cautious man, and our bank is in great shape because of it.

The previous way of valuing securities was at "transaction price"--that is, they were valued at purchase price until they were sold. This meant, of course, that some were over-valued and others under-valued, but on balance it was generally a wash--or, if you had a smart CFO, a gain whose recognition was deferred. Gains and losses were recognized upon sale--at, again, transaction price. This is what is still done with fixed assets such as land and buildings, even in the face of significant appreciation (or the reverse). But asset appreciation isn't really worth a heck of a lot until you sell, is it? It's not money in your pocket until you realize the difference between purchase and sale prices as income. The same logic used to apply to securities, but M2M (in my opinion) gained in popularity as a practice, and eventually became an accounting rule, because many people wanted to recognize asset appreciation from the real estate bubble prior to sale.

You might want to read the Wikipedia entry on M2M. Though it became a common practice in big banks some time ago, it didn't become an accounting *rule* until FASB (Financial Accounting Standards Board "statement number") 157 in November of 2007. It's not like repealing M2M would be overthrowing decades of accounting wisdom. (I am not a huge fan of FASB. They love to tweak bank accounting rules, and many of their "statements" have forced banks to undertake enormous, and not--imo--necessarily helpful or reasonable, accounting changes.)

A lot of banks, unlike my own, do hold CDO securities, many of which--as my CFO presciently observed--cannot be accurately valued. Especially considering that there is essentially no market at all for them at present. (So what do you "mark" to?) They aren't worth what was paid for them, but they also aren't worth nothing. The foreclosure rate is historically high--around 9%, I believe--but that still means the overwhelming majority of the loans bundled into CDOs are either current on payments or at least within 90 days.

On balance I think suspending M2M accounting rules is an idea worth considering. We just don't need the volatility right now. Eventually the losses must be recognized, of course. But forcing recognition of them immediately has a huge ripple effect. If a bank's assets decline precipitously, something must be done on the liability/equity side of the balance sheet to offset it. What? Get rid of some deposits? Easier said than done. Get rid of some capital? In a market where bank runs are a real possibility, is that a good idea?

PS to James--yes, FASB 157 did *force* banks to evaluate ("saleable", not fixed) assets (ie securities) at market price. The phrase they use is "fair value", but that's what it means. Bank accounting is a strange animal.

There are a bunch of examples of conservatives insisting that the market is wrong and is undervaluing things. Examples besides the mark-to-market thing:

a) "Dow 36,000" was based on such an argument.
b) Short-sellers are driving down the prices of financials, so we should ban it.
c) The Paulson plan, to the degree that it was explained, assumed that the "toxic" assets were underpriced.

I don't really know if these are connected. It's just something I've noticed.

It looks like Buffet disagrees with Krugman then about buying at market prices. Market prices would be something like 20 cents on the dollar, right? Interesting. (Unless I misunderstood Krugman, but I don't think I did).

That's my understanding. Buffett says it's a good deal, but his notion of a good deal doesn't meet Krugman's criteria for being a useful bailout.

jerry: Buffett says it's a good deal

As much as I respect Buffett, and have often cited him, let's not forget that he's got serious skin in this game. A bailout may do wonders for his Goldman Sachs investment. He didn't directly answer the question in the interview, but he sure didn't deny it.

Second, as the article pointed out, Buffett thinks it's a good deal if they buy at "market" prices. Do you really trust them to do this instead of playing "it's Christmas courtesy of the taxpayers"? And what happens to the "market" price when Treasury becomes a major part of that market?

Alex,

I respect both Buffett and Krugman as apparently some of the smartest and more liberal cats around.

I think Buffett both wants to make his investment good, and has his understanding of what would be good for the banks. I think that differs in some respect with Krugman's. I suspect there's a lot of validity to both. Krugman the theoretician, Buffett the empiricist.

I just find them both interesting for not being incredibly go-go-go to this bill.

Pavelko--M2M is done when a firm prepares financial statements, which would be quarterly or annually. It's not, as I understand it, done daily.

Jane-in-Colorado--A balance sheet is suppposed to reflect the balance of an entities assets and liabilities at a point in time, not at some hypothetical future date for each individual asset and/or liability. Suppose I, as a potential borrower present my balance sheet to my lender, and I show, on my balance sheet an asset, 10 bonds issued by XYZ, Inc., which I value at my purchase price (which happend to be the face value) of $10,000 per bond--$100,000. But my lender knows that XYZ, Inc. has tanked, and this bond issue is being quoted at $100 per bond. Will any rational lender actually believe I have $100,0000 in assets, just because I say it's so? Even if, holding those bonds to maturity could mean I could get $100,000?

To Anonymous (and why are you anonymous?) at 10:41:

I don't think you get concept of transaction price. Under that system, you don't get to value something you paid $10,000 for at its maturity price. You value it at what you paid for it. If, in fact, it turns out to be worth 10 times its face value, you get to realize that when you sell.

With mark-to-market, you get to value the asset at its market price during the course of its life.

I can promise you that *my* bank won't consider your bond purchase at its maturity value until it is reached.

Kev -

Someone's prob already clued you in, but the wingnuts' screaming about M2M is based on the fact that M2M is somewhat directly the result of Sarbanes-Oxley. Therefore, as you can see, the current meltdown was caused, yes, by TOO MUCH regulation.

These dimwits never quit.

OT: I am saddened to note that Kathleen Parker has belatedly found out that the RW wackosphere is populated largely by violent, angry, threatening vile cranks. One can only surmise that she's not too familiar with the websites on which her work most often appears.

Jane--Dunno why my name didn't show up. I explicitly said that I paid $100,000 for those bonds, which just happened to be the maturity value. But if they aren't worth that when I try to use them valued at my purchase price as a part of my balance sheet, why should anyone reading my balance sheet believe they are? For that matter, why should anyone reading my balance sheet believe anything on it?

FAS 157 requiring consistent use of mark-to-market became effective for fiscal years beginning after Nov 15, 2007. It applies to derivatives and financial instruments for which there is an active market. Prior to that many of those instruments were listed at acquisition cost until actually sold.

The problem with historical cost is that these are cash or near cash instruments. When you want to know how solvent a company is, short-term assets are compared to short-term liabilities to see if the company is solvent in the near term. If short term assets can't cover short term debts, the company is insolvent unless they can borrow the money to pay the debts when due.

The implementation of FAS 157 was fought by managers and bankers for years. Without M2M a company can show solvent balance sheets for years and not be forced into bankruptcy. This in fact was a major reason why the Japanese economic doldrums lasted a decade. Financial instruments were kept for years at acquisition cost when everyone knew they were worth only a fraction of that value. The financial statements were effectively garbage.

Unfortunately, the implementation of FAS 157 coincided roughly with the credit crisis. Application of M2M means that the companies can no longer drift in politely ignored insolvency and hope to someday cover their loses.

Ordinarily companies are assumed to be what is called "going concerns." That is, less-than-liquid assets can be shown on the balance sheet at values at which it might take a lengthy period of time to actually sell them. But if the cash and near-cash assets fall to less than the short-term debts, then suddenly all the assets have to be revalued at fire-sale prices. Managers will do almost anything to avoid being declared not a going-concern. It's a sign of very bad management.

That's what this whole current M2M complaint is all about, and since the entire banking system is facing the same problems the complainers are getting a hearing. Otherwise they would just be failed managers crying in their beer.

It's really not complicated, Kevin.
Conservatives eshew M2M simply because it makes "cooking the books" harder. Truth is a conservative's worst enemy.

It's really not complicated, Kevin.
Conservatives eshew M2M simply because it makes "cooking the books" harder. Truth is a conservative's worst enemy.

Not clear I agree with this. Cooking the books goes two ways. One leads to over-valued (though perhaps still questionable) assets. The other leads to dramatically undervalued assets--more likely in the current environment.

Here's something I sense on these lefty sights. (And I'm a lefty myself, though one who works in a bank she'd like to see, and expects to see, survive.)

But I don't get that the majority of posters here want to see that. I interpret the majority of posts as being a tad nihilist. You'd like to see us all drown, would you not? Good and bad alike?

I wonder how happy you'll be with the consequences.

Previous post was by me. Didn't intend to be Anonymous.

Jane -- I can't speak for anyone else here but I would like to see crooked banks, crooked mortgage companies & crooked securities ratings companies, all of whom colluded to create this disaster, drown.

And I'd prefer their officers/executives drown in jail.

And I'd really prefer that our govt not bail them out, thereby sending the signal that it's OK to do this again because "we've got your back, bro."

As for the banks that did not greedily participate in the market of MBS -- I'd like to see them grow & prosper, as these are the responsible kinds of people we need running our financial system. The people who can spot BS financial instruments & have the good sense to avoid them.

A bailout bill need only do three things -- allow judges or whoever to adjust mortgage terms so people can stay in & continue paying for their homes, re-capitalize troubled financial companies/banks in exchange for equity and tax financial transactions to pay for it. Anything else is a giveaway to people who don't deserve it and implicit permission for them to do it again in the future.

Very good post and excellent comment thread.

I think, however, that Jane is on the right track and her concerns shouldn't be dismissed so lightly. In a volatile financial market, mark-to-market accounting can lead to dire effects even for healthy financial institutions. Mark-to-market doesn't cause the volatility, of course, but balance sheets will necessarily reflect the volatility, perhaps threatening the "going concern" status mentioned by Rick B above.

The problem arises because financial institutions have to meet regulatory targets regarding capital adequacy. Those targets become harder to meet as balance sheets 'deteriorate' to reflect market conditions. The financial institutions can either raise capital (obviously hard to do right now) or reduce lending - which is exactly what we're seeing. And this will eventually have significant ripple effects on the rest of the economy.

I have ignored a number of other factors that feed into the liquidity crunch to focus on the mark-to-market aspect, which certainly can have negative consequences. They shouldn't be ignored because the consequences won't be limited to the bad actors out there.

(I'd say the best solution would not be to dump mark-to-market but for regulators to review / adjust capital adequacy requirements.)

Cheers,

A point that many banks seemed to have overlooked is that in an M2M world, banks need to avoid "custom" and "complex" assets that are hard to value and might not have a market during turbulent times. Or, might have a greatly depressed value just due to their complexity.

It really comes down once more to the problem of over-leverage. The history of finance is full of traders who have made good decisions that the market price of something was wrong. But you can only do this if you have the capital to withstand the market telling you for a long time that you are wrong.

Kevin,
I had never heard of it specifically as the M2M until last Thursday when I was in the car and Dave Ramsey was telling all of his listeners (300 stations) to call their congressional representatives and to vote against the bailout and to take action on the M2M and make this change.

M2M is a regulation, that's why conservatives oppose it. Any government involvement in business is anathema to them. Even after deregulation got us into this mess.

Keep M2M. Tell the banks to suck on it.

I'm the farthest thing from a movement conservative, so I have no answer to the question why they dislike M2M, but I know why I disklike it. It's incredibly inaccurate. It's accurate in the short-term when there's a liquid market. If the market for an asset lacks liquidity all you have is an error of observation. Further, even with a liquid market, it can be incredibly inaccurate because liquid markets get things wrong. If a holder of an asset has the wherewithall and intent to hold an asset long-term it's far more accurate to determine an economic value than a market value.

That opens the window to the prevailing reason why I'm against M2M: All economic activity is better conducted for economic reasons. Accounting treatment of any asset, liability or activity should not provide the reason for economic activity. We are witnessing the stark imperfections of capitalism, but capitalism works better when conducted for economic reasons.

Merrill couldn't hold those assets and remain viable (I surmise from their actions). Undoubtedly another holder can hold them and had another view of the intrisic value of the expected cash flows, and thus used a different risk factor in determining their net present value.

The ability to abuse the judgement calls when estimating economic values exists. M2M is already abusive. I'd rather have a chance at accuracy with a disclosure and a view of the judgements used than the abject inaccuracy of M2M when markets are disfunctional and the consequences of the paper losses of capital are so dramatic.

It is but one component of our markets spiraling out of control.

Dan,

M2M may look inaccurate to you, but if I want to lend to a bank I want to know it will be around to pay me back.

Why would M2M be inaccurate? The only reason is that there is not a good market for the financial instrument. If the bank can't pay me back without selling something for which there is no market, then that seems extremely accurate to me. The fact that there is not a reliable market to provide a solid number to place on the statement is unimportant. My question as a lender was answered very precisely. The absence of the market tells me it is very risky to lend to that organization. It also suggests that they took on risk they did not understand.

Managers always think that given enough time they can fix those problems, but if I am a lender I do not want to risk my money to give them that time without the promise of one Hell of a payoff. Did I just describe one factor in the current credit freeze-up? Yep. But M2M is part of the solution, not the problem.

Rofe,

You've got the idea. The holders of financial instruments need to provide more and better financial statements, not hide the problems. When the problem is systematic, then that is where the regulators have to step in. that's a messy process. But ultimately with better more transparent and accurate financial reporting to assist, the banking system itself becomes more flexible and able to deal with problems by recognizing them early and heading them off.

Anonymous/Jane

I don't want to see any banks go under. I simply think that they should be well-managed, something that does not happen with management is allowed to hide their errors and try to fix them with no one knowing what they are doing.

Transparency is always better than concealing problems. Transparency lets problems be identified while they are still small and relatively controllable. Concealing financial problems just lets them spiral out of control.

If there's no market for something, then in an economic sense it's worthless, no? The possibility that it may be worth something next week is neither here nor there, if no one is willing to bet on it.

Rick B:

"Why would M2M be inaccurate? The only reason is that there is not a good market for the financial instrument."

A better question is what is an asset worth? For years we said, the "cost basis", or marked-to-market of the day of purchase. Now we say mark to today's market. But there's no doubt that the most accurate way to estimate the instrinsic value of an asset, like a mortgage, or a tranch of a mortgage backed security is to sum the net present values of the streams of payments that are owned, appropriately discounted. The discount rate used is obviously where the rub lies. But what if today's M2M significantly underestimates the harshest discount rate one can reasonably assume?

Further, logically there should be a distinction between an asset held by an institution that may immediately seek to sell the asset - assume duress, and an institution that holds assets to maturity.

I strongly doubt these concepts are unfamiliar to comment readers in a discussion of M2M, but it's helpful to remember why instrinsic value is a better measure than market value:

Although business news and trading activity is dominated by short-term thinking, it is most helpful to our economy to stress the benefits of long-term investing. We should encourage long-term assets to find their home in investors who desire to hold them long-term, and who develop business plans to cope with that desire, and do so at a reasonable rate of return. While the fear is palpable that short-term results will overwhelm any long-term thinking it certainly can threaten our economy, capitalism in general, and who-know-what repurcussions it has on our society.

My desire, in support of the new guidance on M2M and a re-writing of the FASB rules, is not to bail us out - it's too late for that - but to get back to a mindset that encourages long-term thinking and investing. There is a side effect of some help to our current ills in that it improves the paper measure of capital in our financial institutions, and perhaps confidence in them if it can be explained in a reasonable fashion.