The Bailout Alternative: Virtual Mark to Market

According to some pundits, the simplest solution to our economic crisis is to suspend or abolish the mark to market accounting rules.

For those unfamiliar. Mark to market is where a company reprices their assets on a daily basis to the most recent market transaction price. If asset prices are falling, this means that the total value of assets on a banks or other company’s books falls. When the total value of assets fall, then those who have lent them money get worried. They are worried because the assets they lent them money against now are worth less. If the borrower cant pay them back, that leaves the lender SOL. SO, the lender demands that the borrower raise cash immediately or add assets to make their asset total higher. If the borrower does not, the lender will either take back enough assets to cover their loan, or find some other way to get their money back.

In a normal market, that wouldn’t necessarily be bad because the borrower could refinance the asset and pay off the original lender. In this market, with credit tight or not available at all, that is not possible. So the borrower ends up selling assets at far below market value to raise cash quickly.

This type of desperation sale is happening everywhere, the latest example is Goldman Sachs sale to Warren Buffet. If enough assets are being sold at firesale prices, the market for those assets collapses, as we have seen with housing prices. This creates a vicious circle. Asset prices are sold at firesale prices. That forces more mark to market writedowns, which in turn forces more firesales. etc, etc.

To some the resolution is to end or suspend mark to market accounting rules. Their logic is obvious. If there is no need to mark to market, then assets are not written down. Banks and other companies are not forced to have firesales to generate capital and prices of assets are not pushed down by the firesales. All good, right ?

Not so fast.

The other side of the coin is that because assets are not being marked to market, shareholders and potential investors have no real idea what the assets on the bank/companies balance sheet are really worth.  When prices are going up, shareholders and investors don’t care. Prices are going up.

When prices are going down, as in this market, cash is dear, and investors and shareholders do not want to take any chances that the asset values on the balance sheets have fallen dramatically. No mark to market, no trust in the balance sheet, which means shareholders run to the exits and there is no one there to buy their shares. Which means banks have to go out and find someone way to raise capital from people who dont know the real value of their assets.

Both routes get us to where we are today: A 700B bailout from you and I the friendly taxpayer

Which leads to my proposal which solves both sides of the coin.

First, let me say that its about time we take advantage of the fact that we live in a broadband enabled society. Our society is now educated to go online for information. We are digital information consumers. Its time we recognize that fact and integrate it into our decision making process.

My proposal is that we suspend mark to market rules, but require complete asset transparency for any company that chooses not to mark to market.  If a company avoids mark to market accounting,  Every asset that  company owns should be required to be listed on their website and updated in REAL TIME on their website. A full asset description, original cost or loan value, value on the books, and latest transaction for this class of asset, or an actual transaction price for the asset.

This means that investors will have the same information available as if the company had marked to market, but their actual balance sheet would not change. The best of both worlds.

I would recommend that every company be required to post this accounting information in a standardized format on a web page, AND to also post a complete comma delineated file that includes all that assets and required info.

Standardization is important as is this asset list. Why ? Because in this digital age, it wont be long till a very smart capatilist, takes all the data and creates a business out of consolidating and publishing the data and possibly even creating an exchange for the data.

If this is done, it allows for several alternatives to the current bailout plan to happen. It allows for what some call the “SwedishPlan” (from the 1992 Swedish bank bailout), but should probably now be called the Warren Buffet Plan or the 3P Plan. It  is the direct purchase of equity from the banks/organizations that need it, in the form of preferred stock and warrants in a 10 plus 10 format. (10pct Perferred, in Perpetuity, callable at 10pct Premium, ie the 3P Plan)

A combination of a 3P plan and the Virtual Mark to Market gives the government a chance to  make money back for taxpayers. It solves the banks problem of liquidity, and it stops the firesale of assets, while most importantly, increasing market transparency and in turn confidence in the market

It allows for the straight purchase of assets, by the Treasury or anyone else. I would of course recommend that any assets sold by institutions to the government then be updated with the price paid , date and who the buyer is. Transparency is king

tell me what you think about this idea.

44 thoughts on “The Bailout Alternative: Virtual Mark to Market

  1. “markets are not always rational.” They often over shoot to the upside and the downside. Let me give you an example. You bought a 3 family house 3 yrs ago for 300k. The rents are enough to pay the mortgage. Now today the house is only worth 150k but no one makes an offer “does that mean the house is worth nothing”. These accounting rules would want you to mark that asset as Zero. Now maybe if the economy gets worse it is worth 120k or possibly the economy gets better and its worth 300k again in the future. As long as the cash flow is there who cares? Now maybe a bank should only be allowed to use 75% of the value if no market currently exists or is currently illiquid but to force the mark to zero is punitive. That is why the banks are not lending. Most importantly it doesn’t cost the government a penny of tax payer money!!! This might not be the best example but it give you the idea of what the banks are facing. Also the need for more regulation is just plain silly. The regulators knew about Maddof and subprime lending, and the woes of the auto industry. The government looked the other way as they were getting there campaign donations. The bottom line is the government is not even good at running the government. Imagine the politics and control the government would have if they could decided what companies and individuals got loans. It would be a political fiasco and the end to the American Economy as they guys as so corrupt that they would sell any of us out for there own special interest including the president! Clinton was such a good president because he did not have the House and Senate. He had to compromise. Obama would be a good president if he were in the same situation but because he has absolute power he is going to wreck the economy to pass a social agenda. The key to change in incremental change. For example how would it look if we had a republican president and republicans with majority in the house and Senate. They could not just say starting tomorrow no one will receive welfare it would create anarchy. Same with this president punishing wall street. Wall street and main street are the same street. Wake up all the folks with IRA’s, 401ks and pensions are getting wiped out. My question is was that the plan? To make us all depend more on government so they can control more of our lives? Wake up people and open your eyes!!!

    Comment by gabe -

  2. Thank you for the summary .. we are doing lojistik and lojistik will be good in some years .. Some lojistik firms are good comme us

    Comment by lojistik -

  3. It seems to me that Mark to Market serves an important purpose, as you have outlined. The problem is with the rate of change. Institutions can not adjust to the rapid vagaries of the market. A time honored method to allow for this is “Running Average”. Use 3 months (100 days) of Daily Mark to Market to value assets. Simple change, which gives time to react.

    Comment by Hroudgar -

  4. Right on. Here’s my analysis: http://tinyurl.com/solve-it

    Comment by Dave Spicer -

  5. TAKE THE 52 BILLION AND

    1. PAY OFF THE NATIONAL DEBT

    2. BUILD HOMES FOR THE POOR AND HELP THEM GET JOBS, AT LEAST THOSE
    THAT WANT TO BETTER THEMSELVES

    3. OUTLAW PORN ON THE INTERNET, CREATE FILTERS THAT WILL FINE
    PEOPLE AND BUSINESS THAT BUY/SALE IN THE SEX TRADE

    4. CREATE A TASK FORCE THAT ONLY DEALS WITH PUNISHING PEOPLE
    IN THE CHILD SEX TRADE

    5. PUT PRAYER BACK IN SCHOOL. BUY A BIBLE FOR EVERY CLASSROOM
    IN AMERICA AND HAVE A 5 MINUTE DAILY DEVOTIONAL, SO THE BLOOD
    OF OUR CHRISTIAN FORFATHERS DOES NOT GO SHED IN VAIN

    Comment by SAMUEL -

  6. XBRL is the solution to the information problem in this market. It is an XBML based specification that defines 12,000 elements in a finanical statement. China, India, Japan, UK, Korea, etc have all started requiring companies to file in this format. The problem today in the US is taht since 1934 companies have to file a document – -a 10k or 10q. As investors have required more information these documents have in some cases become 100 page+ documents explaining minor nuances in account changes quarter over quarter year over year. If someone is trying to follow 10 banks and they have to parse thousands of pages of documents every quarter- they are incapable of adequately assessing the health in any kind of realistic timeframe. Companies and all assett classes (assett backed secuirites, muni bonds, commodities, etc etc) need to use XBRL – -and file data that can be consumed by regulatory and investor analysis software in real time.

    What’s amazing is that Chairman Cox is being declared asleep at the wheel when in facct he has been the biggest champion of getting the market to a data reporting standard. Its unsexxy un glamours there are no perp walks – -its infrastructure! But I think we have all seen that when we dont invest in infrastructure people get hurt.

    XBRL!

    Comment by Philip Moyer -

  7. Additional Illumination On Mark to Market.

    Simply stated, the mark-to-markdown rule states you must assign the value of your bank’s assets according to what the market says they are worth at the time. When the market value of a home drops, the buyer has defaulted on the mortgage, the artificially created demand for homes all across the board has collapsed and years worth of supply has to be worked through, there is no value to the property the bank holds since there are all sellers and no buyers. The value is zero according to the market value. Plain and simple, if you are not willing to make significant concessions to rid yourself of the property in order to keep the defaulting party in the home or find a new buyer (doubtful) at a steep loss, you are required to carry the property at the total loss of mark-to-markdown. Similarly, a third-party will never buy the mortgage which has failed. Banks and investors are not in the business of home ownership and maintenance until the housing supply is exhausted and the mortgage purchaser can recoup the price of the home plus carrying costs on the original mortgage terms acquired by the third-party!

    Suspension of the mark-to-markdown rules would be a return to the over leveraging of capital that created the mess in the first place. One, it allows the banks to create a subjective value for an asset (the mortgage and underlying price of the physical asset of the home) which the market says is worthless and the bank has failed to find a buyer at any price. Two, this is the same situation which infected Freddie and Fannie since it encouraged them to by theses assets on the faulty assumption the home market would be climbing, the underlying mortgages were payable on reasonable terms, mortgage payments would be made and values maintained in perpetuity. NOT! Finally, the suspension of the accounting rules would be a market ruse which essentially permits the bank to again over leverage by over valuing assets for more cheap Fed money. And, lacking confidence on how any other bank has subjectively valued its unsaleable assets, no bank is going to loan another bank money or issue new loans into a market which has been artificially created.

    As the L.A. Times reported,. “Accounting purists say a rule change would raise the risk that the banks would resort to fantasy accounting — “mark to make-believe” — that would overstate the value of their assets to investors. The Center for Audit Quality, an advocacy group for the accounting industry, issued a statement Tuesday urging Congress to reject any suspension of mark-to-market rules, saying that would undermine investor confidence by allowing companies “to mask the actual value of financial assets at a given point in time.”

    No one can say the investment banks, which effectively started the dominos tumbling, were not part of and fueling the mortgage problem. And yet, it was in 2004 that the same investment banks petitioned an obtained SEC approval to allow them special status to leverage their assets up to 40 times compared to the previous 12 times applicable to themselves and banks. This was known as the “Alternative Net Capital Requirements for Broker-Dealers That Are Part of Consolidated Supervised Entities” and which allowed investment banks, including Goldman Sachs being run by Paulson, to subjectively determine “net capital to include securities for which there is no ready market”. Now, the proposal is to allow every financial institution to make its own determination of market value! Talk about not learning from a mistake.

    As an relevant aside, everyone should be calling for Paulson to step aside from participation in the execution of this plan – whatever the final terms. In February 2006, at the latest, Paulson’s Goldman Sachs Group began using an internal and copyrighted Powerpoint presentation entitled “A Primer on the Sub-Prime Market” by the “Goldman Sachs Structured Products Strategy” division. That document indicates how to sell the securities and then states, “Given the belief that house prices in the U.S. are too high, there are several trades that can be executed to short house prices”. In the Spring, Goldman Sachs thereafter sold mortgages tronches, totaling $496 million, to the unwitting clients who lost an estimated 300 million. Goldman however handsomely profited again on the failure of these securities by shorting the market and sales!! See, Sloan article in Washington Post. Instead, notables like PIMCO Investment founder Gross, and David Einhorn of Greenlight Capital, are knowledgeable about the debacle and the house of cards on which it was built. In fact, Mr. Gross stated on CNBC he would run the program for free!

    A more appropriate response to the “mark-to-markdown” rule would be allow a limited waiver of the rule for any mortgage renegotiated with the “primary residence” homebuyer which puts them back in the foreclosed or abandoned home. As a result, the home would be sold, the home occupied, a simplified mortgage based upon actual ability to pay in place, renegotiation taking place at the local level with knowledge of local markets, federal intervention avoided, excess supply removed from the market, a bottom up approach utilized and liquidity enhanced. The changed mortgage could the be valued at the new market as reasonably estimated by the bank. The “Plan” would then be buying assets which tend to re-establish the fair market value and others are more likely to step in when the toxicity is removed. Note the proposed rule waiver would only be applicable to a primary residence. Sorry, no help for flippers and speculators.

    For any one interested in an examination of the greed in sub-prime mortgage the NY Fed noted the overreaching of the effects of the usurious terms ” begs the question why such a loan was made in the first place.” Please search, read and digest: “Understanding the Securitization of Subprime Mortgage Credit”, Staff Report No, 318, by the Federal Reserve Bank of New York, March 2008

    Sorry, we were so rude as to inject a comment on the issue of “mark to market” and its application.

    Lance Free & Jay Dee
    Lance Free Consulting

    Comment by Lance Free & Jay Dee -

  8. I read a lot of comments on suspending Sarbanes Oxley, working in the
    banking industry I am well aware of the insane amount of resources invoked to
    in compliance. In regards to mark to market accounting, one thing people
    are ignoring is that the goal is to get a market value of an assett.
    Guess what people that house people say is worth $150K is only worth $150K
    if someone is willing to pay that. Assets need to have a market to have a value.
    Yes we are in a crisis, yes the assets in question will eventually have a market value, but currently
    a lot of these “assets” are value less because no one wants them and no one is willing to pay fopr them. The concept of marking to market is to capture this fluctuation. It tries to portray what the company can expect from liquidation of said assets. These MBS, CMO, and cds are indeed very risky products which are deemed worthless in large part because they are complex instruments which wall street gurus have convinced the street that they have a handle on valuation. THose valuations are now shot and without transparency no one is willing to price them more than pennies on the dollar.

    Mark to market is not the problem, undercapitalization, over extension, and undying faith in wall street to make risk disappear through aggregation and slicing of securities. Leavfe the mark to market, lets learn from our mistakes and realize there is no value to anything unless someone is willing to buy.

    Comment by Andyr -

  9. I like the basis of your idea(s), especially the suspension of Mark to Marketing. However if we can let our Government purchase these assetts at disocunt rates then why can’t we in this age of the intranet, open up the discount sales for the general public. Why not allow the average folks make investments that could potentialy turn a profit? If the tax payer ultimately takes the hit then why not also enjoy some profitbale benefit. Surely if our government were to somehow miraculaously turn us a profit, it would be spent (or already is spent) before we realized it. Allowing the public to to make these private investment, at discount rates, puts discretion int ot he hands of the American people ) not Henry Paulson) & this would free up the cash for these corrupted, greedy & failed banks and get a free market atmosphere moving again~

    Comment by Fab -

  10. One comment I didn’t read about is marked-up appraisals. Weren’t
    there appraisers working for some of these same institutions that
    are now in trouble? I think so.

    Comment by EG -

  11. Here is a good article regarding mark-to-market accounting, or fair-value accounting in this crises. http://www.cnbc.com/id/6337715/for/cnbc.

    Comment by JM -

  12. To show that Congress was trying, they even included a section about reviewing the mark to market accounting rules. Not that anything would have really been done but at least it shows they read your blog.

    Comment by Tom -

  13. I have had a similar idea. Some thoughts on this here.

    Some commenter mentioned that lenders wouldn’t get fooled and react te same. I think that is probably true. As far as I know, I think the real difference is in the definition of insolvency (or bankruptcy). In other businesses, you are bankrupt when you could not pay a lender back in time. However, in financial services, you can be “called” bankrupt (insolvent?, whatever the term is) even if you are paying all your bills in time. That is, even if you have plenty of cash, you can be announced as dead and unable to pay back. There are capital requirements based on valuation and risk management concepts which use mark-to-market accounting. For the removal of mark-to-market to have a real impact, I think this technical insolvency definition may need to be removed as well (or relaxed). Then, firms will have more time before they stop working.

    Comment by hyokon -

  14. Your idea of two sets of books is a smokescreen…same info presented
    differently. Apparently, the problem is approving loans that
    probably won’t be repaid while the dunderheads who approved them
    walk away with millions of dollars. Industries like to govern
    themselves so that the government won’t step in to govern them; but
    this section of the industry…that got a waiver of restriction…
    probably should be abolished and die. What good does it do people
    to loan them more than they can repay? Why should the people who
    wait until they can afford the home and buy the home they can afford
    pay for those who need immediate gratification or don’t pay for flood i
    insurance when they live in a flood area? Unfortunately, we do have
    to pay for this one because our government(us)let this happen by
    excluding Fanny Mae and Freddy Mac from the normal restrictions that
    were designed to prevent this from happening. I’m sure Obama’s
    Economic advisor, who made $90 mill in 6 years off of this, doesn’t
    give a hoot who was hurt in the process of being so magnanimous.

    Comment by Leslie -

  15. Suspending mark to market is a great idea. For those with reservations about doing so, remember, we would be going back to the asset accounting rules used prior to Sarbanes-Oxley. Therefore, this is not a risky plan or untried concept.

    Comment by Chip Head -

  16. Interesting, but for as much as I love the idea of real-time
    information, I fail to understand how this would help the banks.
    OK, if you suspend mark to market, then the bank won’t technically
    fail, but account holders would know that the bank is
    technically bust if marked to market, and would probably run for their
    money, and investors, that would know that the bank is technically
    on negative equity, would avoid investing in that bank.
    For what I see, the end result would be a bank failure anyway.

    Comment by gianluca -

  17. To me this looks like a fine solution for keeping us out of this situation in the future, which will inevitably occur. But, it doesn’t seem to offer a solution to our current situation from a recovery perspective.
    I guess $700B it is.😦

    Comment by Ryan Graves -

  18. Mark – While your plan definitely provides greater transparency, it does not fix the current problem banks are faced with. As portfolios become more transparent and fully disclosed to investors, the stock price will reflect the value of the bank’s assets. It is best to approve the government bailout and, as taxpayers, accept the losses of others.

    I do agree with your 3P proposal. I look forward to seeing you present these findings to Congress!

    Comment by mfrezz -

  19. I dont see how this plan addresses the fundamental problem here – which is how to do we price assets that we have absolutely no idea what they are worth. If these derivatives are all prices relative to what the other openly traded derivatives are worth, then we have a serious serious problem – because that price is near zero currently. They might have real value as you say but figuring that out is nearly impossible with the current set up. If they are bundled together in these odd arrangements, how could you ever know?

    I dont see how suspending the ability to price these instruments achieves anything other than putting off the inevitable. The fiat currency is the problem as others have pointed out. Its a curency backed by nothing except faith. With these extra debts the government is taking on, it seems lik we are eroding the only thing that holds the dollar up – belief in american capitalism – and thats in damn short supply today.

    Comment by staypuftman -

  20. One more thing…”Bailout” is the wrong word to use. They should be calling it a “Rescue plan that the US government will make money on.” That’s as long as the Democrats don’t pack the bill full of pork, regulations and true bailout money for companies like GM and Ford.

    Comment by andwrig -

  21. I like you idea on full transparency using a standardized format on the webs. That is a good idea. However, I still disagree with you on giving people the option to privatize social security if they want to.

    Comment by andwrig -

  22. 1) No, do not get rid of the mark to market accounting rules!

    2) Yes, we are online, but we need to realize a few things: a) not
    everyone has online access; b) these sites could be checked so often
    (think Facebook) that FREQUENT overloads and crashes occur; c) any
    system that requires real time updates uses more energy and is
    susceptible to other difficulties–imagine if all financial
    institutions were caught up in this!

    3) I don’t think we need to look through this angle in order to fix
    the current problem. We’ve been through worse. However, I do agree
    that more transparency is necessary. I also think better regulation
    would be nice…I don’t mean more rules, but rather, enforcing those
    rules more wisely, i.e., paying more attention to large corporations
    and not trying to use smaller ones as scapegoats.

    4) I said it before, and I’ll say it again: EDUCATION! The
    government can easily encourage savings or make bonds look more
    attractive. There are simple ways to do this; so let’s get on it!

    Comment by the-cuban-responder -

  23. Not only does such a plan exist, you’ve been approahed about investing it it.

    Pricing Mortgage Securities When Nobody Knows Anything
    September 24th, 2008
    Everyone will admit that nobody really knows what the mortgages or the securities derived from them are worth. The market is illiquid to an extreme. The proposed bail out makes it rational to wait to unload them to see what the seller can get later. So, the plans being discussed to reinject liquidity to the market are having the opposite effect. It is making the market go away until mortgage holders can see what the Treasury will pay for them later.

    As William Goldman famously said of movies, nobody knows anything when it comes to predicting what a movie will earn when it finally reaches the market. I showed in my book, Hollywood Economics, that the way to solve the problem of unpredictable results is to set the price later when you do know. That means you set the price when you do know. How is that done? Well, to use the movies as an example, you make contingent contracts that pay based on the revenues a movie earns after it is released. Virtually all the industries contracts follow this principle, which I call the Option Principle. Designing option-like contracts lets you pay when you do know.

    It is easy to apply the Pay When You Know option principle to these distressed mortages and their derivatives. Let every holder of these instruments sell call options on their value. Make the options at least 5 years (preferably 10 years) before they expire so that they do not expire before there is time for a return of liquidity to the market. This would give time for the housing market to recover as well. The option would contain several strike points so that investors with different expectations, risk preferences, and current asset positions can choose to cash in at lower strike points for a quick return while others choose to wait for higher returns. At each strike point, the option would pay a percentage of the value of the asset.

    The option would be designed so that the buyer earns a share of the future value of the mortgage security if it rises. The option would be of no value and would not be exercised if the value of the mortgage security fails to exceed the first, lower strike price. A portion of the value of the security would accrue to the holder of the option so that it shares any appreciation of the value of the mortgage security. The homeowner also should receive a share of the future appreciation. This would give all the parties to the mortgage a share in the future appreciation.

    So, effectively the security holder, the homeowner, and buyer of the option could all share in the future appreciation of the home. This creates good incentives for the homeowner to stay with the mortgage. The cash proceeds of the sale of the option would be shared by the mortgage holder and the homeowner. This gives the holder and the homeowner immediate cash which can be used to pay the mortgage and for the holder to improve the balance sheet.

    This set up could also be used by the Trust if the government sets one up to acquire underperforming mortgages. In this case, the government buys the option rather than the mortgage and shares in the future increase in value when and if the market improves. Thus, a well-designed option would share the benefits of future values among the three parties at risk: the government, the mortgage holder, and the homeowner.

    A simple relaxation of regulation on banks and mortgage regulation would enable this solution. Banks have to have the authority to buy options, mortgage companies have to have authority to issue options, and investors of all stripes should have the authority to buy the options.

    In its basics, this solution is not far removed from a shared appreciation scheme that I think Barney Frank and John McCain have proposed.

    My company, Extremal Security Partners, has many of these issues solved since we are on the verge of launching what we call a Stable Option for motion pictures on a major options exchange. It would be simple to take these principles and create a Mortgage Options market to implement the Frank/McCain proposal and spare the public treasury the hit it seems to have coming under the Paulson Plan. Putting Mortgage options on a liquid and visible exchange would restore much of the liquidity to the mortgage and mortgage.

    When Stable Options begin trading an exchange, individuals will have access over the
    internet. We can set up a portal for individual traders to access the CME order
    ow. This
    portal can supply real time quotes to traders for a fee. The portal can provide access to
    our proprietary software to assist traders and investors in evaluating probabilities, expected
    values and a host of important attributes of the stable options. Our trust could license
    data to the portal on historical returns, prices, strike points, crossing times and a host of
    other data.
    This information is valuable to the studios and is superior to the tracking polls they
    now rely on to plan their release and marketing strategies. It permits them to look at
    market prices to assess probabilities and the value of increased budgets, stars, advertising
    and release patterns. The studios would be among the rst subscribers.
    As the stable option moves from movies to energy, biotech, pharma and other uses,
    the portal would become the central place to access the information and calculations that
    drive trading and arbitrage.
    Eventually, individuals would be able to bid on IPOs of stable options as we industrialize
    the process and no longer negotiate each funding. They would use the portal for that too.
    The portal would become a heavily tracked site for dealing in stable options.
    But, there is a deeper issue. By collecting stable options, whether they trade on the
    CME, Euronext’s LIFFE, Dubai or elsewhere, the portal becomes a web-based investment
    platform. A distributed source of funds and information that fosters high tech and other
    stable industries. Stable options, and the portal to stable options markets will become a
    distributed, decentralized means of funding research and development in innovation indus-
    tries.

    Comment by Aleck Grishkevich -

  24. It is great to see all these free thinkers coming together and sharing ideas. Some are very good, many are not. Either way it is a refreshing change from the usual slanger against Mark Cuban or the ass kissing of Mark Cuban that goes on from day to day.

    Many of you have made comments like “we shouldn’t help the evil banks (paraphrasing)”. Many are suggesting schemes that involve basically working to save and increase the value of foreclosed homes so that they may be sold in the near future. We need to wrap our heads around the true scope of this problem. We are facing a situation where the banks will not lend money to the average consumer for the purchase of these homes. It seems apparent that those responsible for this mess (banks, government, and uneducated consumers) do not fully respect what is going on here. While plans and schemes are debated over and over, things are truely falling apart.

    Mark, your plan is better than most I have seen. The true problem will remain in the fact that nobody on Wall St. is ready for the kind of transparency you suggest. As you have stated in different ways, this crisis requires throwing out almost all the old play books and starting from scratch. I hate to be the bearer of more negativity but since the players involved are not prepared to properly attack this problem, it is about to get a whole lot worse.

    The misuse of mark to market accounting rules caused the collapse of Enron and many of the same things are happening now to the broader market. If you can get someone to truly listen to your ideas then great, but if not, this is about to get a whole lot more interesting

    Comment by Tom M -

  25. Hey Mark. This is the only place I have to vent about the bailout, so I’ll try and keep this short. The reason I am against it is that it seems like we are letting these guys who are getting bailed out rip us off twice. They already made billions and most of this money is sitting in their bank accounts. Now we are going to pay them another $700 Billion, and it seems like most of this is going to end up the same place.

    Comment by Mike -

  26. I have been thinking a lot about this $700 billion bail out. I am so surprised that Wall St. and the Treasury can’t figure out how to fix this problem. Its super easy. We have to STOP the residential real estate pricing from falling further. As it falls, more and more homeowners are underwater and go into foreclosure. To do that, you have to figure out why its falling.

    It’s Simple – foreclosures are driving the market down.

    Every time a homeowner defaults, their home goes through a fire sale and prices drop in that area and make the problem even worse then before. Today, 2.5% of homes are in foreclosure up from 2%. No wonder the housing market is in free fall.

    The answer isn’t using the $700 billion to buy mortgage back securities.

    One, it won’t solve the problem. There are more mortgage back securities outstanding then government and corporate debt combined. $700 billion is a drop in the bucket so those markets will continue to be illiquid even after the bailout. It would take several trillion dollars to solve the problem that way. Two, it doesn’t solve the foreclosure problem. Foreclosures will continue because the real estate market will continue to fall. As a result, the marks on these securities will continue to erode pushing more banks, insurance companies and pension funds into insolvency.

    Let me explain what we should do. To do so, you have to understand how securitizations work. A pool of mortgages gets placed in a trust and then investors buy bonds secured by that pool of assets and the cash flow they throw off.

    The solution to our Wall St. problem is to go the trustees of those pools of mortgages and buy the defaulted loans at a predetermined price. The price is easy. Use the average price per square foot for homes that sold in the last 12 months in that zip code. Then, either modify the loan terms to keep that family in their home or foreclose.

    The TRICK is to NOT SELL these foreclosed homes.

    Through the FHA, the government can put together a rental program that then rents those homes to middle class families. The United States is in desperate need of more rental housing. This problem solves that problem. Then as the market recovers the government can then sell those homes and get back the $700 billion and probably some profit on top of the income from the rentals.

    By NOT SELLING these foreclosed homes, the residential real estate market will quickly recover and home prices will start to rise. Then, homeowners who cannot afford their mortgages will be able to sell their house for a profit or cover their mortgages.

    ALSO, by buying these non performing loans the fundamentals of these mortgage back securities will quickly recover and the market for them will stop seizing up. Then the value of these securities will normalize and the banks, pension funds and insurance companies that own them will stop losing billions of dollars.

    But will this work? The average home in the US is around $300,000. Assuming they are 100% leveraged between first and second mortgages, the government can buy 2.3 million defaulting mortgages. According to the Mortgage Bankers Association, there are 1.1 million homes in foreclosure. That means we could buy 2x the number of mortgages in foreclosure with this $700 billion. That’s much better then buying up less than less than 10% of the mortgage securities.

    This plan does several things:

    1. It stops the free fall in the residential real estate market which will prevent more foreclosures.
    2. It repairs the fundamentals of the ENTIRE mortgage back security market and the marks of these securities will rapidly increase, which breaths life into the banks (they might need some money in the meantime but not hundreds of billions).
    3. It solves our rental housing crisis.
    4. The government will not lose any money and will gain a good stream of cash flow.
    5. It will stem losses at the pension funds that haven’t even been discussed yet.
    6. This also solves the pricing conundrum with the current Paulson plan and helps Main St. WHILE also helping Wall St.

    Comment by Grant Kornman -

  27. Now Mark and others – you know things are in a major meltdown when a guest on Jay Leno makes more sense than financial commentators!

    Over here in Oz we just got the episode where Wanda Sykes opens up about the crisis. She says if the bail out occurs then the CEO’s should line up to get their paycheck at the social security, allow everyone to swim in their pools and have shopping trolleys line the streets of their suburbs!

    Not trying to make light of the situation but as well as discussion of market rules, you’ve got to build in the thing discussed in previous posts – individual behaviour at the top of the corporations (sharing your swimming pool with the folkes whose money you lost and whose tax money is keeping you going seems a pretty good risk barometer to me!)

    cheers from Down Under – and make the right decisions, it affects us all!

    http://www.nbc.com/The_Tonight_Show_with_Jay_Leno/video/clips/wanda-sykes-holding-back-923/693781/

    Comment by Justin Barrie -

  28. Mark- Now you’re on to something. Make this info easily locatable. And there is plenty of media outlets that will summarize and even help interpret the data… all for free to the end user.

    The democratization of technology has led to an increase in availability of knowledge. It should also lead to a commensurate increase in personal responsibility. Sadly, this is the one item that has lagged far behind.

    H. J.
    http://www.hjmann.com

    Comment by HJ Mann -

  29. Mark, I think you need to distinguish this from SarbOx. That has turned into a friggin disaster, and has raised a $3 million barrier to entry for new public companies. There are companies that can’t offer free updates to software because of SarbOx. There are companies that can’t stick a PC and cable modem in a key employee’s home because of SarbOx. It’s insanity trapped in a paradox, locked in a conundrum.

    Comment by BoscoH -

  30. Transparency is key. Your idea is a more honest version of the old RTC when they unloaded savings and loan assets for pennies on the dollar. The transparency will preserve some equity for the financial institutions, thus minimizing the burden on taxpayers.

    Since the credit markets are so tight how would these assets sales get financed?

    Wall street was smart enough to create these financial instruments called CDO and CDS, what solutions have they provided to unwind these instruments?

    Comment by EG -

  31. Mark, the mark to market concept seems like a good one to slow down
    the vicious cycle that happens once liquidity issues come about,
    but i don’t think it deals with the fundamental problem that
    occurred. As I see it, the biggest of all of the problems here is
    that the financial institutions were borrowing money with short term
    debt instruments in order to package up long term cash flows.

    If the market for selling these long-term cash flows (i.e. your home
    loan payments) dries up, but the financial institutions had instead
    borrowed on long-term debt, then financial institutions would
    have had a profitability problem, but not a viability problem.

    Some kind of regulation that ensures long-term cash flows are
    financed with some required amount of long-term debt along with a
    suspension of mark to market (like a suspension of trading) or some
    mark-to-market mechanism like you propose i think puts this issue
    to rest.

    T

    Comment by Travis Kalanick -

  32. Whatever happened to the concept of integrity of results?

    Transparency and full disclosure reporting has been an ongoing challenge
    among regulatory agencies, shareholders, auditors, and enterprise.
    Integrity and accuracy of data are priorities that should be
    integrated and practiced. Right now we can’t and shouldn’t trust the
    data. We would be more inclined to trust data that we can have full
    perspective.

    XBRL (Extensible Business Reporting Language) has already been
    mandated in many countries. Global standardization helps enterprise
    save a lot of money in processing, filing, reporting, and auditing.

    http://conference.xbrl.org/. SEC Chairman Christopher Cox will
    discuss SEC’s mandate of XBRL financial reporting for US companies.

    Comment by StellaYu -

  33. The problem is a defect in the monetary system itself.

    The Federal Reserve keeps interest rates at 2%, while true inflation
    is 20%-30%. This provides an incentive for banks to load up on
    as much leverage as they can. Banks can borrow at 2%, and invest
    in mortgage bonds yielding around 6%. They make the spread of 4%,
    times their leverage ratio, typically 10x-100x, without doing any
    real work.

    Fiat debt-based money has a fundamental structural flaw. It cannot
    be fixed without entirely scrapping the monetary system and trying
    something else. Unfortunately, insiders love the fact that fiat
    money lets them steal from others via inflation. They will not allow
    reform to occur.

    Periodic boom/bust cycles are an inevitable consequence of a corrupt
    economic system. They are not an economic force of nature, as most
    economist falsely say.

    I write about this more on my blog.
    I call this “The Compound Interest Paradox”.

    http://fskrealityguide.blogspot.com/2007/06/compound-interest-paradox.html

    Look at it this way. Most people in the financial industry earn huge
    salaries, even though they do no real work. To offset this, other
    people must perform work while being underpaid.

    When the money in your checking account loses its value to inflation,
    the proceeds are used to fund financial industry profits. It’s a
    zero-sum or negative-sum game.

    Comment by FSK -

  34. I think it’s progress, but I’m not sure it solves the main problem: uncertainty over valuations during market seizures. When there is no market, there is no hard valuation, even if the stuff is all posted on the web. Of course, there would be legions of valuation guys pouring through these to help with that, but at some point, you just have to guess.

    Comment by Damon -

  35. I agree with you to the point of Investors (gamblers) having the access you talk about. However I think a bigger portion of the issue was/is the lack of governmental regulation to keep things above board. Most folks are not Investors (gamblers) that would benefit from the transparency you suggest. Most people are just trying to live their lives, buy their homes, save for retirement and don’t have the time or inclination to follow Wall St, Banking firms etc. They just want to be able to trust that they are not being taken advantage of.

    Comment by GrizDave -

  36. On my blog I write up what I see as the best win-win situation; in a nutshell, I think the government, if they are truly going to use $700B, should suspend the reassessing of property tax to alleviate the current market conditions – and even the liquidity problems currently found within banks. I feel that the government should subsidize the local municipalities with the $700B and, at least for one year, have all property taxes suspended in efforts to spur the economy.
    My article can be found here for those interested:
    http://holdensbestblogever.blogspot.com/2008/09/financial-bailout.html

    Comment by Brian -

  37. Not a bad idea. The problem isn’t that these instruments are worthless, it’s that no one knows how to price them.

    Comment by Jeff D -

  38. Great suggestion! In fact, I suggested something similar several months back. But unlike me, you can get people to listen to you. Go make it happen!

    Comment by Michael F. Martin -

  39. One serious problem with this proposal is that financial
    institutions’ assets — it’s balance sheet — is highly proprietary
    information. For a financial company, the balance sheet contains the
    information that a competitor would need to replicate its success,
    certainly more so than a company in any other business. No bank would
    ever voluntarily reveal their balance sheet, and if they were forced
    to, they could certainly argue that it would be devastating to their
    business.

    For example, hedge funds exist precisely in order to keep their
    balance sheets private, as opposed to mutual funds which are required
    to publish their holdings on a quarterly basis. Without that privacy
    hedge funds lose their raison d’etre. While you could certainly argue
    that is a good thing, the fact that so many hedge funds seek this
    privacy and so many investors are willing to pay absurd fees in order
    to take advantage of the investment opportunities afforded by that
    privacy, it certainly seems to be very valuable.

    It is possible that forcing financial business to shed their “proprietary
    trading” business — e.g. embedded hedge-fund-like operations — would
    be a good thing. In fact that might be the point of your proposal.
    Just understand that it is a fundamental change to the way that banks
    and investment companies do business, and robs them of a great deal
    of their competitive worth.

    Comment by Martin Unsal -

  40. Mark,

    Your ideas are great, but unfortunately it doesn’t seem as though the people who make and enforce these policies really have the ‘greater good’ in mind.

    Comment by Eric -

  41. Banks can’t cure their liquidity woes by paying dividends of 10% (after tax!) on preferred stock. In Goldman’s case they even threw in warrants worth $1.5-2.0billion as as sweetener to drive the effective yields on the preferred even higher. How can a bank borrowing at those kinds of rates turn around and makes loans at a reasonable rate and make any money? Their model is dead. The Buffett sale merely buys them a bit of time while praying for an acquisition or a bailout. Otherwise, they and Morgan Stanley will follow Bear and Lehman. Thain was smart enough to see this and latch onto the first white knight that rode by.

    Comment by Brian -

  42. Federal government to offer loans to the banks capped at a total of 750B. Interest rate to be the same as GS is paying Buffett. The government holds none of the crap paper and receives a nice interest rate. If it is good enough for Buffett then it’s good enough for the taxpayers. The entire bank is to be the collateral and not just the crappy paper.

    Comment by John Caldwell -

  43. The one thing I can add:

    Due to the mark to market law, it showed loans on houses were worth $0.00 because nothing was moving. This is just not true for those loans because there is some tangable asset that the
    loan is attached to. How can a loan be worth $0.00 when there is a $150,000 house that comes with the loan if a foreclosure is needed, thus you would be into the house for about $50k,
    and it is worth$150k when fixed up.

    My point, Mark to Market is just not accurate enough … your proposal above is much better then any other I think I have read or heard (including yesterday).

    Comment by Nation -

  44. It’s not a bad idea, but it won’t fix the problem. What makes you think that lenders wouldn’t do their own calculations of the balance sheet on any company that did this, and still refuse to lend them money in a situation like this? Of course they would.

    The real benefit from this proposal would be to discourage companies from getting into situations like this in the first place, but once their there, the situation will be exactly the same.

    Comment by Skip -

Comments are closed.