Re: We will never agree on this and therefore it is pointless to talk about!
 

What's the reason not to mark to market? $2.6mm is a lot less than 50% of $25mm. Either the market (i.e., the only potential buyer, the most recent seller, and the most recent buyer) is not valuing the bond properly, or the bank's own projections of default and return are wrong. As a general principle of accounting, I am more comfortable with values derived from arms-length transactions between disinterested buyers, rather than values derived from bank employees with computers and incentives to overvalue the bank's books. Is there some reason to think that the bank employees will be more accurate here? They have less information than the market, they're not putting up their own money, and they're not disinterested.

Re: We will never agree on this and therefore it is pointless to talk about!
 

This statement:

and this statement:

cannot live together in harmony.

TM

Re: We will never agree on this and therefore it is pointless to talk about!
 

Actually, parties to a transaction often have information the market doesn't have, as well as access to the market information.

Re: We will never agree on this and therefore it is pointless to talk about!
 

Or because they think they are more valuable today than the market thinks. Or they value the future cash flows at more than the market price (if that is different).

Not necessarily. Businesses are sometimes valued at the sum of the liquidation value of their parts, but that is rarely viewed as their "real" value.

Re: We will never agree on this and therefore it is pointless to talk about!
 

Again, not really. Lot's of the assets on that balance sheet are valued a book (less depreciation).

Re: We will never agree on this and therefore it is pointless to talk about!
 

I must be slow today, because I'm not seeing it.

Re: We will never agree on this and therefore it is pointless to talk about!
 

This is more than a tangential issue here why again?

Re: We will never agree on this and therefore it is pointless to talk about!
 

I don't assume buyers are correct unless the sellers agree.

And why are the banks doing this? They're trying to ride out the storm, and avoid the consequences that GGG points to. Maybe they can't sell the assets and move on. Maybe they can, but are hoping the market will come back before they have to.

For accounting purposes, the value of those assets is what you can get for them. Someone will buy them because she or he thinks they can be used to make more money than that.

The sorts of auctions you described are usually illiquid markets. By letting management maintain operations, you avoid the consequences of selling in those circumstances. For the sorts of assets we've been talking about, I've been assuming a market that was more liquid before the crisis, but now the liquidity has gone away. It may come back -- who knows?

Re: We will never agree on this and therefore it is pointless to talk about!
 

For accounting purposes?

Re: We will never agree on this and therefore it is pointless to talk about!
 

We can say with certainty that they are both wrong. That's the point.

Re: We will never agree on this and therefore it is pointless to talk about!
 

Because it explains the difference between valuation for accounting purposes (mark to market) versus valuation for economic purposes.

Re: We will never agree on this and therefore it is pointless to talk about!
 

Only if you mark to market. Not if you are using another method.

Your argument here is a large circle. Please try again.

Re: We will never agree on this and therefore it is pointless to talk about!
 

Only if it's clear what the replacement is.

That would be great. Seriously. I'd be happy to live in Sebby's world, where changing an accounting rule unleashes the market.

Re: We will never agree on this and therefore it is pointless to talk about!
 

I'm going to stop arguing because you're doing it so much better.

TM

Re: We will never agree on this and therefore it is pointless to talk about!
 

Because if the current holders value the risk in the same way they would agree with the "market" price.

Re: We will never agree on this and therefore it is pointless to talk about!
 

But the hypothetical was that another seller just sold the same instrument to another buyer. I'm assuming each seller has equivalent information.

Re: We will never agree on this and therefore it is pointless to talk about!
 

And we should be fixated primarily on the immediacy of the valuation right now because?

Re: We will never agree on this and therefore it is pointless to talk about!
 

Right. Which is exactly what we are talking about.

Re: We will never agree on this and therefore it is pointless to talk about!
 

No. That was the point.

Re: We will never agree on this and therefore it is pointless to talk about!
 

Banks are not brokerage houses, or at least well run banks are not.

They acquire portfolios of loans and deposits, and, get this, often hold them and service them. They may well make investments with an eye toward fueling their future liquidity, which means laddered bonds which you plan to hold to maturity so you have funds available at maturity. In those cases, what a bank is likely to look at, very hard, is the extent to which there is risk of failure and thus nonpayment, and that will be more important than the current market value, because these were not purchased with an eye toward trading.

You think of the world as one big trader holding securities for resale. This current downturn points out the benefits of a traditionally run bank. Yet you would choose a method of accounting that would encourage that bank, instead, to think only of markets and trading, because that is what they would be judged on.

The everyone's-a-trader approach to value, known as mark to market, is part of the problem, not part of the solution.

Re: We will never agree on this and therefore it is pointless to talk about!
 

For discussion purposes, say my hypo is right (I recognize it's tenuous relation to present reality, but it's supposed to be a simple example). What do we do? The PV of the payment stream is over $25mm, even with 50% default every 2 years, but the only open bid and the last price both say it's worth $2.5mm. Does the bank have to use $2.5mm to comply with OCC rules?

If so, they have ~$30mm to lend instead of ~$300mm, and they are also forgoing tens of millions of actual revenue.

Re: We will never agree on this and therefore it is pointless to talk about!
 

They may agree with the market price, but that doesn't dictate that they will sell at that price.

If you bought an asset at $100 1 year ago that is now valued at $.01 and there is a 99% chance that the risks and uncertainties driving the discount will come true, would you sell? Or would you let it ride? Unless you really need the money, the answer in many cases is that the price you can get today is so low off your purchase price, it is worth it to you to hold and see what happens.

Re: We will never agree on this and therefore it is pointless to talk about!
 

Because that is what financial accounting is designed to do. It measures asset value at a specific point in time. That is why I said earlier that if there is a problem, it isn't with mark to market accounting. We may want to adjust the capital adequacy requirements (temporarily?), but I'm not as familiar with those.

Re: We will never agree on this and therefore it is pointless to talk about!
 

I apologize if I wasn't clear, but the rest of my post, which you omitted from your quote, was an effort to draw the distinction I see between the two differences. There is a difference between a market that is so limited that it will always be pretty illiquid, and a market that is often liquid but where the liquidity has disappeared. In financial markets, liquidity can be valuable. Sometimes more valuable, and sometimes less so. Some trading strategies involve taking a long position that's less liquid and a short position that's more liquid and profiting on the spread. This works well until things turn south, and then it doesn't and you can get killed trying to get out of the illiquid stuff. From my seat, I see that the banks were doing this, got caught with a lot of stuff that no one wants now on their books, and are trying to avoid the consequences by pretending that things haven't changed.

Re: We will never agree on this and therefore it is pointless to talk about!
 

You are not making sense. Every method of valuation determines what the worth of the assets are at a specific moment. You just think that your method of estimating the value of a stream of payments is superior to my method.

TM

Re: We will never agree on this and therefore it is pointless to talk about!
 

But that doesn't mean that we need to let management operate business as ususal, and we don't need to allow them to count the inflated value of those assets in determining how much they can lend.

Re: We will never agree on this and therefore it is pointless to talk about!
 

If what you're saying is true, then a lot of firms shouldn't have been marking to market when the market was on its way up. If the rule shouldn't apply, it shouldn't apply all the time.

Re: We will never agree on this and therefore it is pointless to talk about!
 

You have one bank that calculates a PV of $25+mm. You have three other institutions that calculate it as worth a tenth of that. Why do you think the one is right and the three wrong?

Re: We will never agree on this and therefore it is pointless to talk about!
 

If "the reason why the assets are valued so low is based on the uncertainty and risk that those assets actually will perform in the future" and "that uncertainty is priced in," why would the current holders...given the deep discount" be "willing to take the holding risk?" You just said the risk is priced in.

TM

Re: We will never agree on this and therefore it is pointless to talk about!
 

Exactly. You want a stable banking system, not a banking system focused on market burps.

Mark-to-market was part of the problem.

Re: We will never agree on this and therefore it is pointless to talk about!
 

This, I completely agree with. I think that MTM overstates trends--it shows you up more when the relevant market is up and down more when the relevant market is down, especially if you hold large positions in a particular asset.

Also, don't forget that MTM rules provide a dumping ground for "hard-to-value" assets--Level II (similar asets in the market) and III Assets (no market for the assets or similar assets). If your concern is for transparency, the actual MTM rules don't really help.

Re: We will never agree on this and therefore it is pointless to talk about!
 

You just said the value is what you can sell it for! You're contradicting yourself.

Then you are saying if you hold on to it, there is value there above what it can be sold for right this second.

Stick and move. Stick and move. You've been saying that the value is what you can sell it for right at that second. The purpose of the hypo is to get you to think about an illiquid market and why that particular method of valuation doesn't work for every type of asset.

Yes.

Yes.

Yes!

In a highly liquid market, mark-to-market works great.* In a highly illiquid one (especially this one, in this economic climate, with these products and these sellers), it does not.

I give up.

TM

*For sellers (per Cletus and the link I gave you earlier)

Re: We will never agree on this and therefore it is pointless to talk about!
 

Dude. Stop talking. You are embarassing yourself.

Re: We will never agree on this and therefore it is pointless to talk about!
 

Yes, but there is a difference between valuation at a point in time and whether someone is willing to sell for the market price at that point in time. Just because you are not willing to sell at a price does not make the asset more valuable in an objective sense. The optionality in holding may be more valuable to you, but that doesn't meet we should measure a company's financial condition by that metric.

Re: We will never agree on this and therefore it is pointless to talk about!
 

Still fighting the hypo. The holder may have actual contact with the borrowers so it has better future default data, or it has a plan to maximize the value of any foreclosed homes. The only buyer may want only out-sized returns, may be substantially more pessimistic about the economy, maybe sees foreclosed real estate as only a liability, may have an extremely high cost of capital. Why should it matter? For the rules to work, they need to work in unusual market conditions, too (and this is different from current market conditions in degree only).

Also, related to the MTM rules, in my hypo, the Bond would be a Level II asset, as the prior sale was a *similar* bond, rather than a piece of the same bond. And if it were a piece of the *same* bond, the holder would still use Level II with some bs distinguishing of the sale--different sized holding or whatever.

Re: We will never agree on this and therefore it is pointless to talk about!
 

I am open to the proposition that MTM is not a good way to account as a rule. I am disinclined to the proposition that it should be selectively disregarded when markets turn south.

Re: We will never agree on this and therefore it is pointless to talk about!
 

Your flippant answer is completely empty. No one said it would "unleash" the market. But there are many, many, many people out there who believe it will help.

As a point of fact, if banks do not have to hold huge amounts of cash to counter the $0 value a ridiculous valuation method assigns to a performing asset, credit markets will ease a bit because more money will be available. And isn't that the whole point? You're holding money hostage because you're telling me that these assets aren't worth anything because you can't sell them right now. So all these assets that clearly have value because payments are being made on them are deemed to be worth 2% of what their current cash stream is paying and you think instead of trying to figure out how much money they are likely to continue to bring in, we should continue to force banks to keep cash on the books to cover for the deficiency in value of what they could get for them right now?

We're currently living in your world. It doesn't make any sense, which is why we're changing it.

TM

Re: We will never agree on this and therefore it is pointless to talk about!
 

Or they call them Level 3, and get killed by the market for that, too.

I didn't realize you, Adder, Sebby and GGG were arguing for cafeteria valuation, so I'll have to depart from you there. I think MTM is often enough a bad thing that we shouldn't use it, at least for certain types of entities, the line-drawing for which I am uncertain about.

Re: We will never agree on this and therefore it is pointless to talk about!
 

No. You're shifting the prices and the risk to suit your point. If the risk is built into the price and you know it, then the price is fair and you will sell it. You're just saying $.01 to make it sound bad for the seller. If the risk is built in and you don't sell based on that price (plus a small premium of course), you are acting irrationally.

TM

Re: We will never agree on this and therefore it is pointless to talk about!
 

I was just pointing out that it takes a buyer and seller to set a market price, not just one of the parties.

There may be some value there. That depends on a lot of things, and generally seems to speculative for accounting purposes.

Some assets never trade in liquid markets. I see no reason to apply to MTM to them. Some assets trade in markets than are often liquid, and but turn illiquid when they go south. Saying that you should value those assets with MTM when times are good but not when times are bad is tantamount to saying that you should use accounting rules only when they give you pleasing results.