FUNNY HOW THE MARKET-PURIST RIGHT IS ANTI-MARKET WHEN IT SUITS THEM, EH?:

The Mark-to-Market Melee: Is an obscure accounting rule to blame for the credit market meltdown? (Daniel Gross, April 1, 2008, Slate)

In recent weeks, some have been arguing that just as Abraham Lincoln suspended habeas corpus in a time of war, perhaps regulators should suspend mark-to-market in this time of crisis. Paul Craig Roberts, a veteran supply-sider and former Reagan administration official, wrote on March 11 that the mark-to-market rule "is imploding the U.S. financial system by requiring financial institutions to value subprime mortgages at their current market values." His solution: Suspend the rule, let financial institutions "keep the troubled instruments at book value, or 85-90 percent of book value, until a market forms that can sort out values, and allow financial institutions to write down the subprime mortgages and other troubled instruments over time." In other words, let's assign an imaginary happy value to these assets until the seas grow calmer. Steve Forbes echoed the sentiment in his column in Forbes, calling for a 12-month suspension of mark-to-market in "exotic financial instruments (primarily packages of subprime mortgages)." The reason: "It's preposterous to try to guess what these new instruments are worth in a time of panic." This line of thinking quickly wormed its way into McCain's big economic speech. He put it more anodyne terms: "First, it is time to convene a meeting of the nation's accounting professionals to discuss the current mark-to-market accounting systems. We are witnessing an unprecedented situation as banks and investors try to determine the appropriate value of the assets they are holding, and there is widespread concern that this approach is exacerbating the credit crunch." For its part, the Securities and Exchange Commission issued an opinion letter, in which it told firms, "[I]t is appropriate for you to consider actual market prices, or observable inputs, even when the market is less liquid than historical market volumes, unless those prices are the result of a forced liquidation or distress sale."

The language is technical, but the arguments here are simple and really quite silly—especially coming from folks who value market indicators over all else. These folks are saying that when markets are volatile and irrationally pessimistic, it's just not fair to force people to act as if the market prices are real.

But you'll notice that they never made that argument back when markets were irrationally optimistic, as they were from 2003-2006. No hedge fund manager ever told a bank that it should lend him less money because the value of the collateral he was putting up was clearly a product of unwarranted optimism or that he shouldn't collect management fees based on the assets under management because their value was clearly inflated. Nobody ever complains about the market's ruthlessness and inefficiency when it's making them money.

MORE:
A Conservative Case for the Paulson Plan (Robert T. Miller, September 26, 2008, First Things)

All intelligent conservatives, therefore, recognize that there are known classes of cases where markets do not work. Free-rider problems such as that with national defense present one example, and collective action problems are another. A third—the one relevant in this case—is a market panic. From time to time, market participants become so irrational that markets cease to function because no one is willing to buy or sell. That is exactly what has happened in the mortgage-backed securities market right now. Financial institutions all over the world are holding various kinds of mortgage-backed securities, and everyone knows that these securities are worth less than people paid for them. How much less, however, no one knows for sure. That will ultimately depend on what percent of homeowners default on their mortgages and how much the lenders recover when they foreclose on the loans.

Now, no one believes that the default rate will be all that high (the rate is around 6% now, and even in the Great Depression it never got much above 40%), and everyone knows that when a lender forecloses on a home, it will receive at least most of its money back. Under normal circumstances, market participants would gather the available data, make some informed estimates about these matters, and calculate a price for the relevant securities. Pricing securities is always a very uncertain business, and under normal circumstances this doesn’t bother anyone. Right now, however, people are so panicked about mortgage-backed securities that they will either not buy such securities at all or will pay only absurdly low prices for them. Merrill Lynch, for example, sold some securities like these last July for as little as 22 cents on the dollar. We thus have the most extreme form of market failure imaginable: the total collapse of a market, not because the items traded in the market are valueless (in fact, everyone agrees that they are very valuable), but because people are too panicked to value them.

Such behavior is highly irrational, and savvy people everywhere know it’s highly irrational. Hence we saw that coolest of rational minds, Warren Buffett, buying into Goldman Sachs earlier this week. Once a market-collapsing panic starts, however, it is very difficult to stop. It’s like trying to convince the crowd in the theater that there really is no fire after all. Sometimes, a particularly respected market participant can stop the panic. J.P. Morgan did that in the financial crisis of 1907. Nowadays, however, no private party has the clout to do it.

Fortunately, the government does. What the Paulson plan amounts to is this: The government will buy up all the securities that the market is currently too irrational to value, and it will hold them for a while—long enough for the market to calm down and return to sanity. Then the government will resell the securities into the market. Since the government will have bought the securities at panic prices and sold them at more rational prices, the government may well turn a tidy profit on the deal. Exactly this has happened before. Back in 1998, the Federal Reserve organized the major investment banks to bail-out distressed hedge fund Long Term Capital Management, and when all its positions were finally unwound, the banks had made a profit. There is thus good reason to believe that the treasury will make money, not lose money, on the Paulson plan.