According to a small but powerful group of America's financial decision-makers—mostly supply-siders and those in their thrall—the chief cause of the credit market meltdown is not folly, or reckless lending, or the demise of America's financial management. It's an accounting rule.
"Mark-to-market" is a seemingly innocuous term for the requirement that companies, banks, hedge funds, mutual funds, and the like report the market price of the financial instruments they hold and trade. (Here's some
good background from Morningstar.) Mutual funds that own stocks make such a report every day. Publicly held firms like Bear Stearns must do so at the end of every quarter, and hedge funds must do so on a rolling basis to reassure their creditors that the assets they've put up for collateral are still worth something. Mark-to-market is thus crucial to the functioning of transparent markets.....
When credit started to go bad, market participants had to write down the value of such assets. For institutions holding onto bank loans—an asset for which there is an active secondary market—marking to market was relatively simple. If markets priced bank debt of companies with a particular credit rating at 85 cents on the dollar, banks had to write down 15 cents of the value of each dollar of the loan. This process helped drive the massive write-downs seen at banks like UBS and Citigroup.
But for the complex new financial instruments, the valuations became far more unstable. Many hedge funds and financial institutions had borrowed huge sums of money to buy assets for which there wasn't an active market. When that debt started to go bad, it triggered a chain of unfortunate events. In many instances, funds were forced to sell assets to meet margin calls. Occasionally, creditors would seize assets and sell them. (That's what happened to the Bear Stearns hedge funds that failed last year.) This spiraling activity had the effect of further depressing prices for such instruments. In some instances, buyers disappeared entirely. The valuations of these new instruments also plummeted because of market psychology. In establishing value for assets, funds and banks often relied on newly created indices, such as the
Markit ABX indices. Since those indices are actively traded by investors, they can be driven up and down (mostly down) by speculation and fear.
The end result: The banks and funds holding subprime bonds (which is to say, pretty much the entire global financial complex) have been forced to massively cut the mark-to-market value of their holdings because those values are based on the incredibly pessimistic indices.
In recent weeks, some have been arguing that just as Abraham Lincoln suspended habeas corpus in a time of war, perhaps regulators should suspend mark-to-market in this time of crisis. Paul Craig Roberts, a veteran supply-sider and former Reagan administration official,
wrote on March 11 that
the mark-to-market rule "is imploding the U.S. financial system by requiring financial institutions to value subprime mortgages at their current market values." His solution: Suspend the rule, let financial institutions "keep the troubled instruments at book value, or 85-90 percent of book value, until a market forms that can sort out values, and allow financial institutions to write down the subprime mortgages and other troubled instruments over time." In other words, let's assign an imaginary happy value to these assets until the seas grow calmer. Steve Forbes echoed the sentiment in his
column in
Forbes, calling for a 12-month suspension of mark-to-market in "exotic financial instruments (primarily packages of subprime mortgages)." The reason: "It's preposterous to try to guess what these new instruments are worth in a time of panic."
http://www.slate.com/id/2187880/
