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October 3, 2008
Lack of information
The Wall Street Journal blog Real Time Economics has a great piece - Is Debate Over Mark-to-Market Just a Waste of Time?
The posting summarizes both sides of the debate and ends with the following:
In an excellent post on the Curious Capitalist blog, Justin Fox makes a point that may make the whole debate moot. “Investors and regulators and reporters and corporate executives need to learn not to take any financial reporting numbers, whether marked-to-market or not, at face value. The health of a bank or any corporation can never be adequately measured by a single bottom-line number. Understanding the assumptions and uncertainties inherent in accounting numbers is crucial to understanding how to use them,” he writes.
In the current environment, everyone seems to be taking Fox’s advice. That may be one reason why these markets are frozen in the first place. Even if mark-to-market rules are suspended immediately, it won’t change the makeup of a company’s balance sheet. Investors have decided that these assets are toxic and no matter how a bank accounts for them in its books, that sentiment isn’t likely to change unless investors see some proof that the instruments are actually undervalued. So far, there’s been little to suggest otherwise.
This lack of information about what is on the books is, for me, a major part of the problem. The Real Time Economics piece quotes Brian Wesbury's WSJ op-ed How to Start the Healing Now:
A vast majority of mortgages, corporate bonds, and structured debts are still performing. But because the market is frozen, the prices of these assets have fallen below their true value. Firms that are otherwise solvent must price assets to fire-sale values. Not only does this make them ripe for forced liquidation, but it chases away capital and leads to a further decline in asset values.In other words, many of the so-called toxic assets are not really toxic.
Yet, a recent article by But a recent article by Joe Stiglitz in The Economist’ Voice We Aren’t Done Yet: Comments on the Financial Crises and Bailout implies that most of these assets are toxic and doubts whether they can be valued properly. As an expert on asymmetric information in economic transactions, his warning can not be ignored. Stiglitz also argues that a number of other measure need to be undertaken, such as also getting warrants from the banks in exchange for buying the assets and addressing the underlying housing foreclosure problem. I completely agree. But we also need to figure out how to clean up the books so that everyone knows what is going on – and normal financial exchanges can resume.
In about 2 hours, when the House finishes voting on the package, we will know if we have taken this first step. But the title of Stiglitz’s article is right on point: We aren’t done yet.
And as Fox’s comment underscore, the mark-to-market debate is partially irrelevant. The idea that there is a single number that will give us all the answers about these complex financial instruments is ludicrous. So, the issue should not be focused on solely what the “mark” is – but should revert back to the old math exam requirement: “show your work.” That should be the core of any movement to greater transparency.
Posted by Ken Jarboe at October 3, 2008 10:44 AM
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