Tuesday, March 17, 2009

Insisting that something is a fresh rose does not make it smell sweet

Last Saturday Sam brought up the question of "mark to market" accounting. Most people have completely avoided learning about mark to market accounting because it seems like one of those complicated subjects that are best left to the boring accountants who wear green eyeshades and garters on their sleeves.

But mark to market accounting is actually very simple. Anybody can understand it. Let's take an example.

If you are wise you have probably been saving some money toward retirement. Over the years that money has been slowly building up and you've been investing it, perhaps in stock market mutual funds. For years and years you were generally pleased with the statements you got from the mutual fund company every three months. Last September you looked at your statement and were pleased to see that the $5,000 you had invested over the years had grown into $10,000 or so in the account. Very pleasing!

But then you got a shock when you looked at your statement in December and found that your account had suddenly shrunk as the stock market went down, and the value was back down to about $5,000. Recognizing that the account is worth what its worth is mark to market accounting. Whether you like it or not the value of your investments is what it is. If you're like me you may be pretty optimistic that the value of the account will go back up again over time; but there's absolutely no sense in trying to pretend the account is still worth $10,000. One of the oldest and simplest rules of life is that an economic asset is worth what someone is willing to pay for it, no more and no less.

Some people don't like that simple rule, so they lie to themselves. They tell themselves that their stock market account is still worth $10,000 even though other people in the market are only willing to pay $5,000 for the stocks in the account. Or they tell themselves that their house is worth $200,000 because their neighbor on the right hand side sold his house for $200,000 a couple of years ago, even though they just talked to their neighbor on the left hand side who has had his house listed on the market for six months and the best offer he's gotten so far is $160,000.

Pretending that your stock market account is still worth $10,000 or your house is still worth $200,000 under such conditions is fantasy accounting. It may feel good; but it makes no sense. It's nothing but lying to yourself.

Timothy Geithner and many of the other big heads down in Washington want to let your neighborhood bank pretend that the stocks and bonds and mortgage derivatives in its vault are still worth what they were worth in September. They want to let the bank lie to you and to its owners and claim that those stocks and bonds and mortgage derivatives are worth what they paid for them. Trust me, those stocks and bonds and derivatives in the bank vault are worth what the bank can sell them for today, just like your retirement fund stocks or your house are worth what you can sell them for today.

The big heads claim that the banks need to pretend because there is "no market" for the mortgage derivatives that many stupid bankers bought and put into their vaults. But that too is a pernicious lie. I can assure you that there is a market for mortgage derivatives because I myself am ready to go to any local bank and inspect the paperwork and make an offer for some of their securities.

I'll go further and guarantee that I'm willing to buy a random selection of the mortgage derivatives in the vault of Citibank or Wells Fargo Bank or even AIG even without the chance to inspect them with no more surety than a notarized letter signed by the person who selects the derivatives and the Chairman, Chief Financial Officer and General Counsel assuring me that the selection is truly random, and I don't know very much about derivatives at all.

Heck, I'm even willing to name a price. I'll pay a hundred bucks for ten billion of face value of the mortgage derivatives in the vaults of any of the banks whose stock is listed on the NYSE, sight unseen, under those simple terms - a random selection. So all you bankers with toxic assets; send me the letter and the random selection of derivatives and I'll send you the hundred bucks. If you don't feel comfortable trusting me for the hundred bucks, send me the notarized letter alone and I'll trust you. Even though I know you have a history of lying I'll send you the hundred bucks even before you send the random selection of derivatives.

Give me a few days to put together a team of a two or three folks who know more about mortgage derivatives than me and I'm very confident that we will be willing to pay more, maybe even a thousand or ten thousand bucks per billion of face value, for derivatives if we can visit the vault of Citibank or Wells Fargo or even AIG and pick the ones we're buying. So don't go on telling me there is no market for mortgage derivatives.

I don't expect to be offered the chance to buy mortgage derivatives at those kinds of prices, of course, because there are lots and lots of other people in the world with much more money and much more knowledge of mortgage derivatives than me. And lots and lots of those people already have staffs of people who can help them evaluate the derivatives on very short notice.

There is a market for the so called "toxic assets" of the banks; but the executives of those banks and the big heads down in Washington don't want to recognize that the prices that market is willing to pay is much less than what they are claiming on their fancy accounting statements.


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