And the Crisis is purely a fiction. I am listening to Bernanke in the background testifying in the Senate. None of this would be happening without the Mark to Market rule. None of it. 8% of mortgages have defaulted. Mark to Market has caused 100% of them to marked down creating billions of false, paper losses, and a false lowering of assets, which brings in the regulators applying Capital Requirement Rules, which legally keeps the banks from lending. This freeze has been and continues to be created soley by the Federal Government. Pete Townshend is right. We do live on an immanence front, and it is purely a put on.
The Credit Freeze is 100% purely created by the government, and the solution can be implemented in one day. Simply eliminate “Mark to Market” and return the billions in false paper losses to the banks, so that their Capital structure is sound, their stock prices go back up, and they lend again.
I just heard Bernanke say “There is no ‘magic bullet'” Yes there is. There actually is no “Crisis” but since we are playing make believe, the Magic Bullet is simply to illeminate “Mark to Market” and it all magically goes away. But it is more advantageous to the Establishment to have a Crisis, because they know how to use it to their advantage.
It just occurred to me that this is an exact mirror of the false crisis of the immanence of Iraq’s danger to the U.S. used as an excuse to spend a trillion, actually to line pockets with a trillion. This is a false domestic crisis used as an excuse to spend a trillion, actually to line the pockets of legalized thievery with a trillion. Only its in the name of a “Domestic Crisis” instead of a Foreign Affairs “Crisis”
I posted this on the GilderTech Forum. Here were some responses:
GTF Member 1: “Art Cashin, on cnbc, was begging for them to reinstate, try it for 6 months, it costs nothing and (I think) he feels this would solve the crisis.”
GTF Member 2: ” why do you think Bernanke, the historian, who knows what happened in the 30s with mark to market isn’t pushing to suspend it. How about the banks and Larry Summers, not sure what geithner’s agenda is but Bernanke must be aware of the history of and problems with mark to market. Brian Wesbury has been pushing this and telling everybody to call their congress people but why will they listen to us, the unwashed masses?”
GTF Member 2 again: “George, any insight on this refusal to suspend mark to market?”
Me: “What do Mortgage Backed Securities consist of? Just the Mortgage itself or are they mixed together with other instruments including the debt, warrents, preferred or common stock of the bank itself? What is causing the ‘cloud’? Because even Mike Holland said last Friday there were private investors ready to come in and pay 27-30 cents on the dollar for the so called “toxic assets” until the ‘cloud’ of Government intervention itself stepped in and then they froze and stepped back.”
Me: “I thought Mark to Market wasn’t initiated until 1992. I thought I heard Steve Forbes said that. Not true?”
GTF Member 3: “Yes, creating and using big problems is part of the plan for the “New World Order”.
Am I right, or am I right?”
GTF Member 4: “I think the “crisis” was created by short sellers, possibly with political interests, who leveraged the rule in September by shorting assets that were used as collateral and, as a result, creating huge and predicable margin calls in the finance sector.”
GTF Member 5: “Brian Wesbury – 2-23-09
Don’t Nationalize; Suspend Mark-to-Market
We have been accused of beating a dead horse when it
comes to our support for either suspension of, or targeted
relief from, market-to-market accounting.
And we suppose after writing thousands of words,
producing videos and giving speeches about the issue, some
might be tempted to let it go. But, we can‚Äôt do that,
especially when the government continues to spend trillions
of dollars and is coming very close to bank nationalization.
This is a real shame. Suspending mark-to-market
accounting could fix major problems at no cost.
Unfortunately, many people dismiss this issue without really
understanding its impact on the economy.
The history seems clear. Mark-to-market accounting
existed in the Great Depression and according to Milton
Friedman, who wrote about it just 30 years after the fact, it
was responsible for the failure of many banks.
Franklin Roosevelt suspended it in 1938, and between
then and 2007 there were no panics or depressions. But,
when FASB 157 went into effect in 2007, reintroducing
mark-to-market accounting, look what happened.
Two things are absolutely essential when fixing financial
market problems ‚ Time and Growth. Time to work things
out and growth to make working those things out easier.
Mark-to-market accounting takes both of these away.
Because these accounting rules force banks to write-off
losses before they even happen, we lose time. This happens
because markets are forward looking. For example, the price
of many securitized mortgage pools is well below their value
based on cash flows. In other words, the market is pricing in
more losses than have actually, or may ever, occur. The
accounting rules force banks to take artificial hits to capital
without reference to the actual performance of loans.
And this affects growth. By wiping out capital, fair
value accounting rules undermine the banking system,
increase the odds of asset fire sales and make markets even
less liquid. As this happened in 2008, investment banks
failed and the government proposed bailouts. This drove
prices down even further, which hurt the economy. And
now as growth suffers, bad loans multiply. It‚Äôs a vicious
In the 1980s and 1990s, there were at least as many, and
probably more, bad loans in the banking system as a share of
the economy. The difference was that there was no mark-tomarket
accounting. This gave banks time to work through
the problems. At the same time, the US cut marginal tax
rates and raised interest rates, which helped lift economic
growth. Time and growth allowed those major banking
problems to be absorbed (even though roughly 3000 banks
failed); without creating an economic catastrophe.
In Japan, during the 1990s, the government allowed
banks to operate without ever even recognizing bad loans,
which certainly bought time. However, Japan increased
taxes, which undermined growth, creating an economic
catastrophe. The real problem with Japan was not zombie
banks, it was that there was no growth. After all, foreign
banks were allowed to lend in Japan, but stayed away
because the economy was not vibrant.
Suspending mark-to-market accounting is a cost free
way to buy time. It does not allow banks to sweep bad loans
under the rug. Bad loans are still bad loans and banks cannot
hide from them. Not suspending it, while at the same time
interfering in the economy with massive stimulus bills and
bank nationalization, is a recipe to undermine both time and
growth and therefore hurt the economy even more.”
Member 4 again: “Published at Next Inning on January 23rd:
As was the case with reinstating the uptick rule, I was an early advocate for suspending the Mark to Market rule and replacing it with a system that I think would offer greater transparency, a more realistic picture of value, more stable asset pricing and lower volatility. With these benefits, I think it would also lessen the risk aversion that envelops our markets and help slow the deflationary pressures most asset classes are seeing today.
The short story is that Mark to Market rules weigh the liquidity portion of the value proposition way too heavily. Due to this, in a Mark to Market world, asset values are needlessly and dangerously volatile. When liquidity was good, certain liquidity sensitive asset values were too high and now that we’re suffering through what I termed in August 2007 as “The Global Freezing of Liquidity,” these liquidity sensitive asset values are being calculated as being too low. Let’s take a minute to look at what happened when liquidity was high before we evaluate what we’re facing today.
When Liquidity is Too High
The ultra high liquidity that former Fed Chairman Alan Greenspan dumped on the market and the leverage mills it created that our government refused to regulate are at the core of our problems we face today. During these times when money flowed like spiked kool-aid, bankers could easily “package” all forms of debt into fancy alphabet soup securities and sell them to a market that was punch-drunk thirsty for extra yield. Even ratings agencies used the artificially high liquidity of these instruments to justify giving many of them their highest possible credit ratings.
One example of the problems caused by this seemingly innocent system of valuation was the once very popular ARS (Auction Rate Security). ARS’ were not invented during the hyper-liquid times we abruptly exited a couple years ago, but it was during those years that they rose from being a niche instrument to a mainstream method of juicing returns in what corporations could term as “cash equivalent investments.” This market was created by the convergence of low Treasury yields, which is what corporations normally used for cash equivalent investments, and too much liquidity (a lot of cash in the system).
Stated in overly simplified terms, the backing of an ARS is a long-term debt obligation, often from highly credit-worthy institutions like Georgetown University or solvent municipal governments, that is recast as an ARS in a fashion that allows it to masquerade as a short-term investment. To set up this marketing ploy, investment banks put together packages of these credit-worthy long-term debt obligations and held weekly, bi-monthly or monthly auctions; hence the name “ARS.” Due to the fact that these ARS’ were traded on a frequent basis, they met the FASB definition of “cash equivalent” and were therefore allowed to be carried at the top of corporate balance sheets as a current cash asset.
This scheme worked really well so long as the system was drowning in liquidity and Treasury rates were unreasonably low. Under these conditions, there were seldom shortages of interested auction participants. To back the image of liquidity the banks were selling, when there were temporary shortages of bidders, the banks themselves would step up and fill the void – kind of like the shill at a three card monte game would bait the next sucker. And why were banks doing all this? Simple, they were raking in handsome fees on the spread between the long-term rates and the short-term rates. Banks would collect the higher long-term rates and sell the ARS’ at a premium just slightly above the short-term rate to customers that clearly had more cash than brains.
Bottom Line for the Good Times: So long as the snake oil selling banks could lure suckers to its auctions, they could find bidders for ARS’ and the Ponzi-like scheme worked. However, just like when candidates for the next link of a chain letter disappear, so did liquidity in the ARS markets and, as a result of Mark to Market rules, so did the value of the ARS elixir that was sold as the “cash-equivalent” cure for low Treasury yields.
When Liquidity is Too Low
As the spigot of liquidity was tuned off, the auctions for ARS’ ceased. Without these auctions that provided liquidity, ARS’ instantly went from cash equivalents that carried the highest possible ratings from our “respected” ratings agencies like Standard & Poor’s, Fitches and Moody’s, to illiquid assets with no valid open market measure to determine their value. Simply stated, there were no markets for these assets and in a Mark to Market world, when there is no current market yard stick to use in the measurement of value, the corporations that owned the ARS’ were put in a box.
When liquidity disappeared so did the high credit ratings that the ARS’ carried and, in many cases, this happened nearly overnight. This meant corporations had to do two things.
First, corporations were forced, and rightfully so, to reclassify these assets as long-term versus their former short-term “current asset” classification. This meant they could no longer list these assets on balance sheets as cash equivalents and thereby be considered by investors a part of the net cash balance. This is a very big deal since popular valuation methods for corporations add net cash dollar for dollar to the value of a company, but all but ignore the value of “long-term investments.” Worse yet, many corporations, particularly in the financial world, which used the value of these assets as collateral for loans received the dreaded margin call – put up cash or repay the loan.
Second, the corporations holding ARS’ were forced to use Mark to Market rules to determine the value of these ARS’. The problem was that no market existed. Due to this and the real threat posed by Sarbanes Oxley (SarbOx) rules that could result in executives being fitted for orange jump suits and connected bracelets, corporations took the only logical road; they wrote the values down sharply so that neither attorney generals nor shareholders in class action law suits could accuse them later of inflating their balance sheets.
Bottom Line for Bad Times: When liquidity was high it juiced valuations so much that instruments like ARS’ and securtized mortgage debt was spun into a potpourri of alphabet soup securities and sold like hotcakes. This created a wide and complex infrastructure designed to feed the demand for these investments and, in time, some aspects of this structure got sloppy, greedy and rife with corruption. However, when aggregate liquidity fell off a cliff, there were no interested buyers and therefore no market for the investments that now littered balance sheets around the world.
Mark To Market
The theoretical goal for Mark to Market is to provide investors with transparent valuations that react quickly to changes in the market. Viewed from another perspective, it is to keep everyone honest. Both are admirable goals. However, due to its very strong tie to liquidity, bankers devised methods to leverage the tie when we were awash in liquidity.
To do this, bankers grabbed the sharp dual-edged Mark to Market sword and cut a fat swath of profit by creating and leveraging illusions of liquidity. This was easy and, to at least some degree, obvious; with excess liquidity and low rates for short risk-free returns, there was huge demand for higher than market cash equivalent returns. With high demand, you get high values and with that, you get a rush to fill the supply void.
Now that we are living in a world where there is precious little liquidity, the back side of this Mark to Market sword is cutting the value of these once inflated assets to ribbons and, with them, the world economy. Unfortunately, even as we bleed, those who have the power to set the sword down, letting time and reconstruction actions initiate the healing process, refuse to let go.
Make no mistake, the rules governing valuations should not be changed willy-nilly. To a great extent, the belief that the rules of value are inflexible is the cornerstone of trust and trust is the most important component of value; much more so than liquidity or even return on investment. Due to this, I don’t take lightly at all weighing in against Mark to Market policies. However, after giving it careful thought, I continue to believe it is a flawed policy that does not support its goals and should be suspended if not permanently replaced.
What the banking industry terms as “non-performing assets” are not the core of our problems today. While there are clearly assets that are not performing to contract (foreclosures, etc.) and in fact the percentage of them is higher today than usual, the majority of the core long-term assets supporting this mess are performing to contract. In other words, while the secondary assets like, but not limited to, ARS’ no longer have the liquidity to be considered cash equivalent investments and therefore should no longer carry the premium associated with cash equivalent investments, the underlying long-term core assets from which they were spawned are not necessarily non-performing assets.
Based on this thinking, I believe holders of assets should have two choices with one being Mark to Market. However, in my view, Mark to Market would only be an option if the value of the asset was being declared at par (face value) or less. The other option, which I’ll call for now “NPV” (Net Present Value) would be required if an asset is being represented at a value higher than could be supported with Mark to Market or at any value above par.
NPV would give the asset holder the option to provide copious transparency into the construction of the asset. In addition to requiring the holder to fully define the asset, it would require the holder to gain a fresh rating from an independent agency based on the asset’s value when held to full maturity. In other words, the value of an ARS would be based on the full term of the underlying debt and the rating of that debt and then be discounted against the risk free rate of return. With this, the holder would then factor the NPV (a well defined calculation).
Why This is Important
There is no shortage of pundits anxious to point fingers at what caused the mess we are facing today. While it may be true that history will show us there was one cause, until we know that, I think the better way to view our situation is that it was caused by a convergence of events that have created a self-feeding negative spiral. In this, Mark to Market policy is calorie rich food.
One of the classic ways to defeat an enemy, particularly if you don’t know how you might fare with a frontal assault, is to cut off the enemy’s supply of nutrition. While we most certainly should not relax the regulatory policy of our financial institutions, particularly when these policies address something as core as value, we need to be open minded enough to recognize when bad policy is working against our collective interests. There are a number of policies today, Mark to Market being only one, that are food for our enemy.”
Member 4 again: “Suspending M2M is a No Cost Step – Here’s a step that would actually increase tax revenues and stimulate the formation of capital.
If your business is down and aggregate demand is slack, what do you do; raise prices or lower prices (have a sale)? I know your answer, but our government doesn’t agree.
Of course, you lower prices in hopes that higher aggregate revenues will help you meet fixed costs and maintain enough market share to where you are well positioned when demand improves.
John Chambers estimates that if the government would have a “sale” by lowering the cost of repatriating foreign profits it would collect roughly $37B in federal income taxes and, by my estimate, slightly more in state income taxes. In the process, it would bring about $700B into the U.S. for investment. Personally, I’m inclined to trust Chamber’s numbers – CSCO currently has about 90% of its liquid cash equivalent assets trapped outside the U.S.
The Senate discussed including this in the stimulus package, but summarily decided against it. You see, according to Senate math, 35% (the full tax rate for repatriated foreign profits) times near zero repatriation would cost us over $200B. In other words, 35% of nothing, according to Senate math, is greater than 5.25% (the proposed temporary discounted rate for repatriation) of something.”
GTF Member: “I thought the problem was that these individual mortgages were bundled in such a way and sold as package deals as to make it nearly impossible to unbundle them to separate out the individual mortgages?
Consequently a few rotten apples spoil the entire barrel? The actual real estate didn’t go anywhere. But the underlying paper is in a netherworld…sold like hot merchandise….fenced by Mazerati driving investment bankers….to unsuspecting foreign pension funds….who now hold worthless paper?
Every owner of real estate should demand of their lender to see all the legal documents securing their property. If the proper paperwork can’t be produced in a timely fashion….within a deadline….then that debt should be wiped off the books and a new deed issued to the owner. If the lender’s portion of the equity is marked to zero, then possession should be nine tenths of the law.
Just a brain fart.”
GTF Member: “My only insight is that the economists in Washington are all trying to avoid the Japanese trap of pretending their banks were solvent for a decade when they were not. It is a conservative accounting impulse to recognize reality and not allow the banks to perpetuate delusory balance sheets. I think the mark-to-marketeers are wrong, that mark-to-market creates not a purchase on reality but a depressionary delusion. But it would help if someone would cogently refute the Japanese precedent.”
GTF Member: “One of the very important points in the M2M debate that I’ve not seen addressed anywhere but in the post above is that it significantly juiced calculated valuations when there was high liquidity. That is exactly why investment banks repackaged long-term debt into instruments that could be sold as cash equivalents. M2M created an implicit carry trade that was very lucrative.
Me: “Could you explain this to me in a little more detail? My Financial Knowledge is limited and I don’t understand a lot of the jargon.
My argument is that the balance sheets aren’t delusory, but that they are making them Mark down the 92% performing ones on account of the 8% in default, even when they are being held to maturity. I’m also trying to say that it’s the government itself marking the assets down that has frozen the market, that its not free market pricing.
I guess I need to look up exactly what Mortgage Backed Securities are. Are they securities that are a mixture of Mortgage debt with other types of debt or securities, and was the Mortgage part of the equation unfairly taken down on account of the vulnerablity of these other instruments thus exacerbating the housing meldown?“