OK, so I was just a lowly English major in college, so I have a hard time wrapping my head around financial issues. I don't get how mark-to-market is ethical as it is based on some future valuation that we can't possible know will come to fruition. And, in the Real Clear Markets link, the author uses Internet companies as an example. Didn't the dot com bubble burst about ten years ago? Aren't shady accounting practices what led to the collapse of Enron? Someone help me out here. This seems to be a big GOP talking point of late, and I haven't any idea what it really means, why they think it's a good idea, and why it might not be.

The whole "mark to market" question is a lot more complicated--both morally and economically than either liberals or conservatives--or just people yearning for want it to be.

"Mark to market" was imposed in response to a specific abuse. Companies and banks were taking advantage of a loophole that let them assign damn near any value they wanted to assets or debits that did not trade on a regulated exchange or have other generally recognized valuation methodologies (as is the case with real property).

From the premise that it was really hard to accurately value thus stuff because there was no regular market, which was quite true, the companies naturally concluded they they were free to cook their books by pulling values out of their asses, which was not true, and also mendacious and evil.

As a result, we ended up with absurdly high values assigned to high-risk class C collateralized debt obligations backed by sub-prime mortgages because the issuer had gotten the credit rating agencies to whore out a AAA for them on the basis of a credit default swap unbacked by reserves. Or, under the same theory, they were massively understating the value of stock options granted to executives to keep from pissing off the shareholders.

The regulatory solution to this problem was the "mark to market" rule. Basically, the SEC and GAAP said, "if you if you're going to abuse the valuation discretion we gave you, we'll just take it away. So now we don't care if there's not a competitive market for this crap; now the amount anyone will pay for the class of assets is what you have to book, no matter how inefficient and devoid of competition the market may be."

So what's wrong with that? The market knows what stuff's worth, right? Indeed, econ 101 says nothing is worth more than someone will pay you for it, right?

Well, yeah, that's kind of true. No matter what the Simplistic Bozos for Paul say, nothing has intrinsic value, not even that sometimes useful shiny yellow heavy metal they so adore. But its also kind of not true. How much is the Mona Lisa worth? The French aren't sellin' so there's no way of knowing without resort to speculation, which is what "mark to market" is supposed to prevent. And there are no comparables--what compares to the Mona Lisa?

Well CDOs ain't the Mona Lisa and there are at least a few buyers. The problem is buyers are scarce because no one knows what the default rate is going to turn out to be on the mortgates that back them; they only know it is increasing and there's no end in view. Therefore anyone who is willing to buy even "good" CDOs--Class A's backed by 30 year 20% down mortgages--offers a price that's so low that there is virtually no economic catastrophe that leaves civilization standing that could drive the default rate high enough to make the buyer take a loss. And as for the bad stuff--there's no market at all. Want some CDO's from backed by subprime interest only ARMS? No? Not even from the "A" tranche? C'mon, its not possible that all of those mortgages are going to default--so they have to be worth something, right?

Well, not according to "mark to market." No one has credit. Anyone with money is hanging on to it because they're terrified. Those who are still interested in buying up some debt can buy better debt than the bad CDO's super-cheap. Because no one wants to buy subprime-backed CDO's they are, according to "mark to market," valueless even if they are still generating substantial income.

It is axiomatic in both law and economics (with apologies to U. of Chicago grads) that any asset that generates a stream of income has value. Yet, according to "mark to market," if no one will buy the asset because they don't yet know what that stream will turn out to be-- and won't know until we hit bottom-- it has no value for purposes of accounting.

That, in turn, means that a bank that owns them is technically "insolvent" even though the "worthless" assets do have, and will have, an income stream, and, hence, substantial value. That "insolvency," in turn, causes Paul Krugman to call the owners "zombies" and stridently demand nationalization and causes rigid doctrinaire Republican blowhards to demand that you be dissolved. And that, in turn, increases buyer uncertainty about the value of the the assets, further shinking the market, further increasing the number of income-generating CDO's deemed "valuless," and, P.S. and btw, requiring further increases in the capital reserves of AIG and other credit default swap issuerers, which pulls more money out of the capital markets, which further decreases the marekt for CDO's and downward we spiral.

I have no idea what the answer is. I have no idea how to value CDO's when we don't know how bad the mortgage default rate will get before it bottoms out. I totatally do not trust these guys to value honestly if they are given any discretion whatsoever, so I see the need for a bright line rule. However, I also think that the particular bright line rule they chose, mark to market, will ultimately have the perverse effect of making things--everything--worse.

Do you have to have an idiot gene to be in the Republican party?

Awesome post NCSteve, formerly. thx

Dumb Azz Congressman!