Saga of Financial Markets


Last updateSat, 29 Jul 2017 12am

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Mark-to-market is worsening the financial crisis

Market rally? It seems. The index is up by more than 10% just within four days! One of the reasons for the market to rally recently is the anticipation of abolishing the ‘fair value’ accounting rule also known as mark to market (MTM) accounting, which sets the value of the assets on the balance sheet to reflect their market sale prices.

Under such a rule, declining housing prices don’t just reduce the value of defaulting mortgages. They reduce the value of all mortgages and all mortgage-related securities because the housing collateral protecting them is worthless.As a matter of fact, not all securities are liquid. According to hierarchy of assets, all securities may classified as one of the followings:

  1. Level 1 assets – market prices.

  2. Level 2 assets – don’t have market prices; they are marked at fair value based on a model. the model is fed with inputs for which there are market prices (prices of similar securities, interest rates, etc.).

  3. Level 3 assets – don’t have available market prices for the model inputs, forcing the people preparing the financial statements to make assumptions about those inputs’ values.

Apparently, at this time, most banks’ asset are classified Level 3 and as such pundits believe that the financial crisis is worsening because of MTM and the financial crisis would be ‘resolved’ if MTM were to be abolished or suspended for the time being till the market recovers. From their perspectives, banks are forced by irrational markets to mark down the value of their assets.


WE GOT MARK TO MARKET ACCOUNTING! (Photo credit: antjeverena)

Interestingly, Bloomberg News columnist David Reilly’s article pointed out that:

“…Figures provided by banks themselves in their 2008 filings show otherwise.

Of the $8.46 trillion in assets held by the 12 largest banks in KBW Bank Index, only 29% is marked to market prices, according to my analysis of company data. General Electric Co., meanwhile, said last week that just 2% of assets were marked to market at its General Electric Capital Corp. subsidiary, which is similar in size to the sixth-biggest U.S. bank…Of the 12 banks in the KBW that I reviewed, only 5% of total assets on average were designated as being hard to value because market-based prices weren’t available.

These so-called mark-to-myth assets represented 58% on average of total shareholders’ equity among the banks. They fall, though, to just 16% of equity if the Big Four banks – Bank of America Corp., Citigroup Inc., JPMorgan Chase & Co. and Wells Fargo & Co. – are excluded.”

Reilly might have rightly pointed out that MTM is being used as a scapegoat by banks and others to dodge two big issues – their reckless use of borrowed money to boost returns and their instability to make sound loans and investments.

Reference:  Bloomberg, David Reilly, 2009-03-11, “Elivs Lives, and Mark-to-Market Rules Fuel Crisis