September 15, 2008

ROE V. SOLVENCY:

Why Mark To Market? (Bob McTeer 09.15.08, Forbes)

I refer primarily to mark to market accounting, which forces firms to revalue their assets to current market values even when the market is frozen or dysfunctional and even when the assets could be held to maturity and redeemed at face value.

If a bank loan goes into default, it makes sense to write it off the books. If a borrower has missed several payments, it makes sense to set aside a provision for the likely loss. But if a security trades lower because market interest rates have risen or because of problems in the market itself, requiring an immediate write-down is unduly harsh, because capital is reduced by the same amount.

Because capital is usually, and legitimately, a small percentage of assets, capital can easily go to zero and a perfectly sound institution can be declared insolvent and taken over by its insurer or some other government agencies.

“Prompt corrective action,” also adopted as one the “reforms” of the early 1990s, makes the matter worse by allowing the authorities to pull the trigger before capital reaches zero. Its purpose is to reduce the cost of “resolving” (read “taking over”) troubled institutions, but what it amounts to is shooting the sick and wounded to expedite the burial. Efficiency and cost effectiveness trumps fairness.


Putting otherwise healthy businesses out of your misery seems a dubious proposition.

Posted by Orrin Judd at September 15, 2008 6:21 AM
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