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Mark to Market Caused the Subprime Crisis

Posted June 5, 2008

“Once upon a time, asset valuation was easy, even for banks. Whatever you paid for it (the asset) was the value at which you carried it in the books.” — Martin Hutchinson

by Martin Hutchinson

Baltimore – (TFN): “When I use a word” said Humpty Dumpty in Lewis Carroll’s Through the Looking-Glass, “it means just what I choose it to mean, neither more nor less.”

It has always been the ambition of Wall Street to bring its financial statements under a similar type of discipline. And if the The Institute for International Finance Inc.’s new proposal on “mark to market” accounting is implemented, Wall Street will have achieved this objective.

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Needless to say, that would be bad news for shareholders.

Value manipulation inflates subprime losses

Once upon a time, asset valuation was easy, even for banks. Whatever you paid for it (the asset) was the value at which you carried it in the books. In the years of inflation, shysters would wander round the country looking for companies that carried their Head Office at its value when built in 1926.

The only exception was in the few cases such as dud bank loans. If the asset was clearly worth far less than you paid for it, then you would write it down to a new lower value. More often than not, you wrote it off altogether and forgot about it. However, if you wanted credit for an asset’s increase in value, you had to sell it - simple as that.

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The only exception to this methodology arose in a few trading operations, such as the investment banks - at the time, much smaller - and commodities traders, where positions were written up or down, or in other words, “marked-to-market” at the end of each day, according to that day’s closing prices. By and large, the only assets marked to market in this way were actively traded shares and bonds.

The advantage of this system for shareholders is that it was difficult for management to play games. Read on to learn why.

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Posted by Martin Hutchinson · Filed Under US Stocks and Markets 

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