Mark to Market

I'm a huge fan of Dave Ramsey, but as I've been busy keeping up with things at work lately, I haven't spent a lot of time listening to his show. So today as I was walking the dog I listened to a couple shows from last week.

As you would imagine, the main topic of discussion was the financial crisis and the pending bailout. Dave spent considerable time in a "teaching" section of the show saying that one of the primary causes of this financial crisis was the "mark-to-market" rule in Sarbanes Oxley. Dave urged his thousands of listeners to call their congressmen and congresswomen and demand that they change the mark-to-market rule.

So what is mark-to-market? It's an accounting rule that says that when a company is valuing the assets on their books, they should use the market value (rather than the price that they paid, for example). Sounds reasonable, right? It's a market-based approach to determining the value of assets.

So how was mark-to-market involved in this crisis? It turns out that the investment banks were not only selling a lot of these CDOs (the mortgages bundled into bonds) to investors, but they were keeping a lot for themselves (not sure if it's because they really wanted them or if they just couldn't move them fast enough). As these CDOs plummeted in value on the market, these banks had to update their books to reflect that the value of their assets had decreased.

So what would eliminating the mark-to-market rule do? Without mark-to-market, the banks could claim that the CDOs were still worth what they paid for them. It would allow any public company inflate their balance sheets by hiding the true value of their assets.

Don't we want (shouldn't we demand) transparency from our public companies? Of course. So which is the correct valuation of assets? The market value of course! That's what the market does! I'm sorry to say, Dave, but removing the transparancy and hiding the problems under a rock is NOT a solution. Most every economist is saying so; it's only in the political arena that this is being discussed ... so why is that?

Much like the "blame the poor for it" approach, the "blame regulation for it" approach is the next best thing for Republicans who thought that free markets would solve any problem. So Dave urged his thousands of listeners to call their congressmen and congresswomen and demand that they change the mark-to-market rule. As I mentioned, these shows were from a week ago, so I can only assume that Dave and others like him were part of what caused House Republicans to have their "the Democrats will have to pass the bailout" moment last week.

I predict that in four years, as Republicans are preparing to run against an incumbent President Obama, that they will resurrect this theory of over-regulation as both the cause and the neglected solution for the financial crisis of 2008. Don't buy it!


J-Wild said...

Happened to randomly catch him on the Huckabee show. He was talking about abandoning Sarbanes Oxley until he was blue in the face. Seemed fishy to me, thanks for clearing it up.

russandrebecca said...

Yeah, I just saw Huckabee proposing the same "over regulated" hypothesis. The truth is, Ramsey needs to stick with micro-economics not macro. Macro is not his specialty and he shouldn't try to extend his influence to cover market trends and controls. We will not see less SOX-type regulation as a result of these current events... we will see A LOT more.

happytheman said...

I'm have no clue really so I'm asking is there an opportunity to have equity kickers like there were with Chrysler in 79?

Brandon said...

Yeah, you've got it. The plan that was rejected by the House yesterday included "equity kickers" -- the Treasury would have been given warrants to buy stock of firms participating in the bailout, just as they did with Chrysler.

Anonymous said...

Came on this through Joe Hays blog. Question--rather than pricing the assets at zero, should they not be valued at net realizable value? The way I understand is crisis is being caused by this "zero" value concept while our glorious leader as saying that there is value. Which is no value or some value? It would seem to me that any workout would only involve the estimated realizable losses. Am I on the wrong track?

Brandon said...

The principle is to apply the market value. If the security is trading at just 30 cents on the dollar -- and it's a working market -- then that's the best possible estimate for what it's worth. Like any bond, it may end up being worth more or may be less. The huge discount on these securities (30 cents on the dollar is just something I heard anecdotally) would seem to reflect a belief that the foreclosure rate isn't going to slow down any time soon. Considering all of the folks out there who took adjustable rates, it seems like a reasonable expectation to me.

Ben Mankin said...

BB--Hope all is well with you. No one is talking about or connecting the dots that mark-to-market is one of the root causes of Enron's downfall--they legally doctored the books by using mark-to-market accouting practices to put on the books today an income stream of a future asset (like a powerplant not built yet in India).