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Marked-to-Market

October 2nd, 2008

While I wait for the Vice Presidential Debacle–I mean, Debate–to start, I figured I’d drop a quick post about Marked-to-Market, for those trying to make heads or tails of the bailout business up on the Hill this week. Let me start by saying I have not made up my mind about the bailout, and one of the big advantages about not being being a member of Congress is that I’m not required to. I once heard a Congressional Chief of Staff observe that Congress people are paid to have incredibly well informed opinions. And it’s true, with a staff of at least six people and all the time in the world to think about issues, I should expect their opinions to be infinitely more informed than my own… not that this makes them right.

Anyway, as everyone knows, the House Republicans killed the bailout bill on Monday saying that government intervention into the market is (a) always bad and (b) unneeded. I don’t buy (a), and that certainly makes me wonder about (b), but they seemed so darn certain… and seeing as how these are the people that Wall Street Fat Cats got elected for their “pro-growth” policies and thus should be first in line to give money to their corporate overlords, I wanted to know more about (b) before I dismissed it out of hand.

Members of the Republican Study Committee argue there are a set of non-interventionist options available to unfreeze the currently frozen credit markets. Besides ever popular policies like more tax cuts, their chief proposal is to abolish the Securities Exchange Commission’s Marked-to-Market rule. Here’s the rule in jist form:

When reporting assets, as all publicly traded companies do, assets must be valued at what they would fetch on the open market

Which is to say, if I have 10 head of cattle which I could sell today for $1000, then I report $1000 worth of cattle as my assets. It also means that even if I believe the cattle will be worth $10,000 in two months time, I cannot state that today… because it’s not the current fair market value.

The RSC argues that the Marked-to-Market policy is what has frozen the credit markets because there are no buyers, of any kind, for the toxic securities backed by foreclosed mortgages that started this mess. As a result, financial institutions holding these assets must report them as being worth ZERO dollars. Which, if you think about it, is absurd. Even if the mortgages are in foreclosure, there is a house underneath all that paperwork that is worth something. It may not be worth what it was originally sold for, but it’s sure worth more than zero. However, because the SEC requires assets be marked to the current market value, and no one is buying the securities, that’s exactly how it is valued.

So, the RSC has a point… maybe if we eliminated the Marked-to-Market rule, the banks could post healthier looking balance sheets, with higher capitalization, and things could start getting better. It just might work… but lest we forget, there was a reason the Marked-to-Market rule exists at all. If estimating the value of something based on some potential future sounds familiar, that’s good–means you are paying attention–because that is what Enron did. They valued their various energy trading deals based on a projected value of assets that didn’t exist. As a result, Enron looked great on paper, but in reality, it had nothing.

The question then for our well informed Congress people is this… how do you allow holders of these toxic securities to estimate their true value while avoiding Enron type behavior?

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