The Corner

A Mark-to-Market Email

From reader F.T.:

If 29% of assets are mark-to-market today (after markdowns), what proportion were they a year ago when this problem was rearing its head? With prices of many mortgage securites–RMBS, CMBS & CDOs priced south of 50–due to distressed liquidations at fire-sale prices–the year-earlier proportion could have been roughly twice as large. No bank has sufficient capital for an asset category to take a 50% hit.

 

Triple-A mortgage securities only required a 1.2% capital charge (reserve), so even a small price move would be distorting (and devastating) to the capital position.

 

The distressed selling causes lower asset marks, requiring banks to raise capital, raise liquidity, forcing more selling, while investors sit and wait for even lower prices because they know the banks have to sell. It’s a game of musical chairs and hot potato.

 

Markets are frozen because no bank wants lower asset marks–it’s in none of the banks’ interests to cause another round of vicious mark-downs. I think its Reilly who’s confused about frozen markets and the concept of mark-to-market.

 

And he gave away his confusion/ignorance by comparing the accounting for loans and securities–as if there’s some mystical “market price” for loans that is detached from the accounting treatment. Which is precisely the point, i.e. if the cash flow from the investment is performing, why write-down its value as a charge-off against capital? If it is performing sub-optimally, write it down accordingly. This is not done based on a subjective judgment, but objectively based on cash-flow performance.

 

There much more wrong with the article, but I’m getting a headache thinking about his inane observations.

Ramesh Ponnuru is a senior editor for National Review, a columnist for Bloomberg Opinion, a visiting fellow at the American Enterprise Institute, and a senior fellow at the National Review Institute.

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