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MTM..


bargainman
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Does anyone else think this is a disaster waiting to happen?  The original MTM probably ignited the financial crisis.  No one could find a bid for any of their assets so they had to mark them down to nothing.

 

http://www.navellier.com/blogs/entry.aspx?ID=124

http://www.americanbanker.com/bulletins/-1020090-1.html

http://ftalphaville.ft.com/blog/2010/05/28/246171/fasbs-mark-to-mayhem/

 

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Mark to market did not precipitate the credit crisis.  Overleveraged institutions did.  Mark to market will force some accountability on the amount of risk financial institutions expose themselves to.  Why is it that financial institutions feel comfortable with 20-1, 30-1 leverage?  They shouldn't!  Why do they believe that volatility in portfolios or pension assets should not occur?  Or how they mark reserves in insurance companies? 

 

Prem has no problem with mark to market.  I don't think Buffett & Munger do either.  Those businesses with good underwriting practices on loans, insurance policies, etc will do fine long-term under MTM.  It's those businesses that have less than stellar practices that should be worried.  Cheers! 

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Mark to market did not precipitate the credit crisis.  Overleveraged institutions did.  Mark to market will force some accountability on the amount of risk financial institutions expose themselves to.  Why is it that financial institutions feel comfortable with 20-1, 30-1 leverage?  They shouldn't!  Why do they believe that volatility in portfolios or pension assets should not occur?  Or how they mark reserves in insurance companies? 

 

Prem has no problem with mark to market.  I don't think Buffett & Munger do either.  Those businesses with good underwriting practices on loans, insurance policies, etc will do fine long-term under MTM.  It's those businesses that have less than stellar practices that should be worried.  Cheers! 

 

Sanjeev,

 

I disagree.  MTM was one of the sparks.  Of course, like with any massive fire, there was a lot of flammable liquid around, but MTM had a spark like effect on all the massive leverage.

 

My beef with this is the 'changing the rules in the middle of the game' aspect of what the FASB is once again proposing.  Remember how Buffett was trying to get an exclusion from posting collateral against his derivatives, but Congress didn't make an exception?  Then he said that "legally since the contract was written before the change, BRK won't have to post collateral anyway, but he'd rather stay out of court?"  This is close to the same thing.  The problem is not the MTM but the Capital ratios that are based off of those assets.  Assets which are already on the balance sheet.  Picture this scenario:

 

I get a mortgage 30 year fixed on a $1 million house, I put 20% down (200K), and I agree to a certain amount of payment every year for the next 30 years.  Now the price of the house on the market all of a sudden drops 40%.  Well, it sucks, but I don't care cause I just keep paying my monthly payment.  Now what if the FASB said.. oh, you have to *NOW* MTM your asset and post collateral on it!  Well now the bank will come to me and say.. hey, it's a 800K loan, and the house is only worth 600K, so you have to give us 200K+(600K*20%)= 320K, cause you have to keep your capital ratio in balance!  To which I'll say "What the? that's not what we were originally doing? How come the rules changed?  I can't post that much!  I'll have to raise capital.. but I can't cause the house isn't worth anything...  oh I'll have to declare bankruptcy..  Or go to Uncle Sam for a bailout!"

 

I could have continued paying the yearly payment and paid off the loan with no problem, but now that the rules changed midstream and I have to keep my capital requirements in balance I'm bankrupt!

 

If FASB wants to have MTM for all NEW assets being acquired I'm not so opposed to that..  But they shouldn't be changing all the rules midstream for old assets.  That's what caused all the banks to have to raise capital when they could least afford it, which was one of the clear factors affecting the death spiral.  Also it leaves securities which don't have liquid bids in a very susceptible position, even if they are performing.

 

Anyway, regardless of what opinion you or I or anyone has on this, that wasn't my question.  My question was.. is it a disaster waiting to happen?  Will this cause all the banks to have to simultaneously have to raise capital and take huge markdowns again?  If it passes my guess is it will.. Especially since they are supposedly requiring it for equities and loans this time.

 

But I'm not an accountant or a banker, so I was wondering what others with more expertise in this area thought...

 

Ericopoly..  What is TCE?

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The Economist had an article about this and also talked about the convergence with IFRS.

 

One wants mark to model, one mark to market.

They touched on the banking issue, and noted it was stupid to have 1 set of accounting because you have 2 different interests.

 

Investors want a liquidation value, and perhaps historical info.

Regulators want to know what your capital situation looks like.

 

They thought the 2 should be unlinked, Regulators should do their thing, and investors should get the info they want. Basically provide both.

 

Big Business and Congress both dont like MTM, so I dont think it will stick. Basically only the bean counters (me being one of them), want it because it makes our lives much easier and reduces liabilities and estimates.

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To answer your question, TCE is "tangible common equity"

 

Prem need not care -- his primary business is not that of making loans.

 

Prem might care if he were asked to boost reserves every time the market got scared that a hurricane was imminent.

 

But I suppose FASB can do what it wants -- they aren't the bank regulator and the regulator can always choose to work off the old system.

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Prem need not care -- his primary business is not that of making loans.

 

Prem might care if he were asked to boost reserves every time the market got scared that a hurricane was imminent.

 

Sure he cares!  Fairfax has had to report under FASB 157 like everyone else.  They've had to mark to market their investment portfolio for a while now.  That means they have to readjust reserves if their capital ratios rise or fall.  And that's what all other institutions will have to do. 

 

It will hurt in the beginning, but it will reduce the total amount of risk that institutions expose themselves to...or at the very least, you won't see risk capitulate in such a manner as the last few years, but you'll see institutions having to readjust capital levels on a regular basis.

 

My question was.. is it a disaster waiting to happen?  Will this cause all the banks to have to simultaneously have to raise capital and take huge markdowns again?  If it passes my guess is it will.. Especially since they are supposedly requiring it for equities and loans this time.

 

Not a disaster, but it could have some short-term impact on institutions as they increase their capital base.  If they enact it in a draconian fashion, forcing institutions to raise huge amounts of capital immediately, then it could be a problem, but I think mark-to-market is better used as a tool to indicate current circumstances and force institutions to assess their current risk levels.  Here's a good blog post article on your mortgage analogy and the way mark to market should be enforced.  Cheers!

 

http://jenniferfitz.wordpress.com/2009/03/11/warren-buffet-mark-to-market/

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Prem need not care -- his primary business is not that of making loans.

 

Prem might care if he were asked to boost reserves every time the market got scared that a hurricane was imminent.

 

Sure he cares!  Fairfax has had to report under FASB 157 like everyone else.  They've had to mark to market their investment portfolio for a while now.  That means they have to readjust reserves if their capital ratios rise or fall.  And that's what all other institutions will have to do.  

 

Insurance companies can reach for more return by exposing their investment portfolios to mark-to-market risk the way Prem does.  Or they can invest in short-term treasuries to eliminate most of that risk, and focus on underwriting profits instead.  There is a choice in business model for the insurance company.  I think it's appropriate for investments to be marked to market for insurance companies -- after all, where do we expect them to find the capital for paying claims?  I also think it's appropriate for banks to mark investments to market.  However, I was attempting to make a more subtle point regarding the underlying business that they are involved in.  If a bank makes a loan to hold on their books based on their intimate understanding of the borrower... is the performance of that loan determined by the market which isn't going to have the time to understand the borrower anywhere near as well?  That's why conforming loans are easy for a bank to sell in the secondary market -- the market understands the Fannie/Freddie guidelines.  But for borrowers that don't fit the Fannie/Freddie guidelines, the banks' underwriters investigate the situation for the individual borrower and keep it on their books.  It will get even harder for non-conforming individuals to get a loan because the secondary market won't understand the individuals custom circumstances.  So it will probably drive up the cost of loans for such people as a means of the banks offsetting their risk to tangible equity levels -- I suspect that's the cost of this "transparency".  But if you ask Mr. Buffett, TCE isn't what matters anyway -- he wants to look at the earnings power, at least that's how I understand his investment in Wells Fargo.  Even in the depths last year, Wells Fargo pre-tax was earning double the losses on loans -- so there was a huge margin of safety there.  Other banks were at roughly break-even -- you could see which bank was in the stronger position without knowing how things were marked to an illiquid market.

 

Insurance companies are lucky that Mr. Market isn't looking over their shoulder telling them how much they have to reserve for the claims estimates.  That's the subtle difference... banks make a loan based on their assessment of the borrowers ability to repay.  If they are comfortable with the risk and if they have the expertise, they can make the loan -- but under FASB proposal Mr. Market is looking over their shoulder and (due to temporary illiquidity in general) can say -- oh, no way the loan is worth that much, you need to boost reserves!   Well, there isn't a Mr. Market looking at Fairfax's reserves... but if there was it would be stupid, don't you agree?  All you would need to do is set up a secondary market where other insurance companies could bid on the accuracy of one-anothers individual claims liabilities -- oh, if the market bids are too low, then so sorry, you have to boost your reserves!  (suspension of disbelief -- for a moment pretend that they wouldn't be malicious about this, given that they are competitors)

 

Alternatively, how about if Fairfax were invested solely in cash, yet were asked to solicit bids from third party insurance companies on how much their entire book of business is worth (similar to Berkshire bidding on somebody's runoff business)... supposing they were asked during a period of illiquidity in the markets and then forced to put up more capital if the bids came in too low?  There must be a point where the market will "fair" value for your reserves, in which case you are accurately reserved and therefore you have no need to boost your reserves.  But if the market only offers you 1/2 of "fair" value, then you had better start selling equity (during an illiquid market) to raise capital and boost your reserves.

 

 

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Not a disaster, but it could have some short-term impact on institutions as they increase their capital base.  If they enact it in a draconian fashion, forcing institutions to raise huge amounts of capital immediately, then it could be a problem, but I think mark-to-market is better used as a tool to indicate current circumstances and force institutions to assess their current risk levels.  Here's a good blog post article on your mortgage analogy and the way mark to market should be enforced.  Cheers!

 

http://jenniferfitz.wordpress.com/2009/03/11/warren-buffet-mark-to-market/

 

I can pretty much agree with the article.  I have no problem with MTM to report income or financial statements.. But when it comes to regulatory capital requirements... you can't run a business that way.  The problem is that it certainly doesn't sound like the FASB is synced up with the capital requirements regulators.  If they could both do MTM accounting and change the capital requirements regs in one coordinated dance, then that'd be fine.  But I doubt that will happen.

 

From what the articles say it's going to be even more restrictive than the previous MTM fiasco.  But hopefully bank's balance sheets are in better shape...  I guess time will tell, but it's something to watch...

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My post was too long.

 

I should have just asked a simple question:  would Mr. Market's input on Fairfax's reserving bring more transparency to investors?

 

 

Very good, question which sums things up. I think we all agree on the answer for this considering the share price over the last few years.

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My post was too long.

 

I should have just asked a simple question:  would Mr. Market's input on Fairfax's reserving bring more transparency to investors?

 

 

Very good, question which sums things up. I think we all agree on the answer for this considering the share price over the last few years.

 

Thanks, because I wish I had just asked that question earlier.

 

Insurance reserves are marked to model/myth.  If it's adequate for insurance, why don't people agree it is also adequate for banks?

 

Does Mr. Market know more about the risks in Markel's porftfolio than Markel?  I say NO!  I therefore trust mark-to-model.

 

Munger says, "To a man with a hammer, everything looks like a nail.".  I say, sure, mark-to-market probably seems fair for valuation of passive investments, but when it comes to in-house underwriting I'd say the model may very well know more about the default characteristics than the passive investor (Mr. Market).  So that's why I support mark-to-market for passive investments, but for in-house underwriting I support mark-to-model.

 

The hammer is "mark-to-market".  Everything looks like a nail to some people.

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I think there is a practical issue here to.  How would you mark to market an illiquid loan/derviative to a business that does have publicly traded securities?  Which is probably most loans.  You take your best guess and knowing accountants they will want to be as conservative as possible.  Does this help you determine the quality of the loan? or the banks underwriting standards from the outside?  Probably not.  This may help internal management of loans and for that purpose it probably has a wide uncertainty bounds but will it help the outside investor?  Probably not as promotional managers will try to inflate/game the numbers.  My bottom line question is will this addition data in the hands of an outside investor help him/her develop a better valuation?  I am skeptical.

 

Packer

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I should have just asked a simple question:  would Mr. Market's input on Fairfax's reserving bring more transparency to investors?

 

In another sense, there actually is mark-to-market also for insurers reserving - at least for public companies: The share price is set by the market and contain the markets opinion on the reserving.

 

Regarding  mark to market of loans on the books of the banks. Shouldn't a logical extension of this be, to allow borrowers bidding for (part of) their own loans? After all the borrower might have a lot of knowledge about the underlying value and might be the onewith the highest bid in a free market. This way the borrowers could buy back (part of) their loan at a discount if they deemed it a good value.

 

Cheers

 

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If I'm asking for a loan and the institution want to know how much I'm worth, do they wish me to disclose my equities portfolio value in any other way than MTM? Ironic, isn't it?

 

If I'm buying a new life insurance policy and I smoke, how about using a lung scan that I had 10 years ago?

 

I mean, when I hear a bank complaining about MTM accounting, it does not sounds far more different than hearing a car driver complaining that it is because of the radar that he got a police ticket, not because he was driving too fast!

 

Cheers!

 

 

 

 

 

 

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