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Macro Economic Trends and Risks
Mark to Market vs. Mark to Value

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By Thomfranklin
October 1, 2008

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Will going back to mark to value models this late in the game save the FIRE Economy?

I believe the bigger problem which would be faced should mark to market be dropped - even temporarily - for a mark to value model is this: no one alive today can tell you what the $62 Trillion in derivatives (nominal value) are really worth - unless you were to unwind them all.

I realize not all derivatives are MBS based. Yet no one can give us any idea how many bets depend on MBS paper, even as side bets. So many bets have been made for/against the paper, as either insurance or some unrelated bets, that the only way to mark to value is to send out Super Forensic Accountants across the planet to track down the fractional remnants of a mortgage which is now being argued before a court where a lender is trying to foreclose.

We have people making mortgage payments to entities in this country which no longer own the underlying paper (mortgage) for those payments. We've read these stories on Fool where case after case, judges tell the lenders to quit wasting their time if they cannot produce 100% clear ownership of a title. The judges, in essence, are telling lender's lawyers, "This is akin to Habeus corpus. Instead of producing a body, you must produce the title which you claim to own outright."

In case after case, the original lender cannot trace the paper and electronic trail showing where all the fractional pieces of the title were sold off, as the different tranches of a person's mortgage were further bet upon and used as a collateral on myriad derivatives.

Why mark to value in this crisis cannot happen

No one can tell you what the underlying value of the MSBs are worth as no one can trace the real value of each mortgage in a tranche. Tranches were marked to market by ratings agencies. We know how that worked out.

Whereas ratings agencies used to be autonomous entities where all banks came to them to buy their solid independent due diligence on ratings, the agencies began to work directly for certain investment banks. Like a fraudulent appraiser who is thrown work by a lender the more he overvalues a home he's inspecting, the same thing happened with ratings agencies who had incestuous relationships with banks's MSBs they were rating.

Ratings agencies took the worst paper, gave the uppermost tranch a high rating, because relatively speaking, the upper tranche of the crap was better than the lower most bit of crap

If you fell into an outhouse toilet feet first and your head was barely sticking out of the muck, would you rather try to rise above the muck by pulling yourself out, or would you dive down and try to dig a hole out of your hole? If a man happened along and said, "Do you want a rope, or do you want a shovel," which would you value more?

If you said the rope, welcome, you just bought an AAA tranche of junk Mortgage Backed Securities.

AAA tranches are made up of zillions of different slices of loans. You could assign a value for an AAA tranche saying "These are worth 80 cents on the dollar," but the problem is some of the slices of individual mortgages are worth 100 cents, some are worth 0 cents. So, for a bank to recoup value of a good loan, it has to go into all these sold off mortgages, delicately and surgically remove the value of an individual mortgage which the bank claims to own from the Tranche Corpus, and then show the underlying mortgage, once re-assembled as one mortgage body, is now worth "X" dollars as this particular loan is/is not being paid by the borrower in timely fashion.

Furthering this problem is the time factor needed to investigate what mark to value should be: No one on Earth has any idea on any given day which loans are callable. Many homeowners, just today, just minutes ago, have walked away or defaulted. Whereas foreclosure proceedings used to take a few weeks, we find it's taking months and years to foreclose upon people these days due to processors being swamped by paperwork.

If mark to value proponents in banking wanted to have real time valuing of the crap loans they hold, the paperwork and electronic accounting to chase all this down would require a bureaucracy the size of our Federal government. Who is going to pay for this bureaucracy? Who is going to pay for all this valuing of marked stuff which will take years to unwind and give value to?

Like many people on this board, I am a Berkshire investor. Remember when Warren was speaking out against the derivatives Time Bomb, especially when it hit home to him (and us) in the form of the years long unwind of General Re derivatives?

Does this nation have the leisure Warren Buffet's General Re had to take years to unwind derivatives and mark the underlying paper to its real value?

I think not.

So how do you change back to mark to value in a crisis such as this?

I don't think we have the time to allow banks to change the rules of the game back to an older system where assets were given true value. Not only this, but no two banks on either side of a derivatives bet are going to agree to a value which later can be found to be worth more or less upstream. Even with mark to market, the whole chain reaction is blowing up one bet after another, upstream, midstream and downstream.

Mark to value seems a lost cause at this date to me

What would we do? Invent a new Dictator of Value who pulls corporate heads of all corporations in the world using mark to market into a giant meeting inside a soccer stadium where he holds a green flag, drops it, and says "The value of all this junk is "X", account accordingly . . . "?

What I'm saying is, marking to value is an impossibility at this time when it comes to companies which dabbled in derivatives and mark to market wizardry.

Trying to mark this crap to its real value will cost too much

Here's the scary thought about the value of much of this crap: the value would change on day 1 from something with possible low double digit value to something of negative value on Day 500. I say this because the value will shift everyday as derivatives upstream and downstream on the underlying paper are going to change daily. The cost to determine real value of this paper will waste more money and manpower than the paper is worth. It is similar to an oil company drilling holes in the Earth for cheap oil which isn't there. There is no more cheap oil. The new fields are in hard to get areas. For the oil company to pursue hard to get oil, the oil company needs oil to stay above $100 so it can recover its costs of drilling in deep seas. A giant bureaucracy would benefit only accountants needing jobs. But the company or entity put in charge of finding true value of MBS paper and its derivatives would be a gigantic losing venture with negative value in itself.

Libertarians wanting no government regulation of business are barking up the wrong tree too. You got what you wished for with Mark to Market accounting and unregulated businesses trading in derivatives.


A word to my friends who are Libertarians: we tried unbridled capitalism recently. It failed miserably due to unbridled greed by sociopathic white collar bankers, traders, hedge fund operators, etc.

By having no regulation of hedge funds and the derivatives market, we allowed a world of players to suck giant gobs of capital out in the form of bonuses and salaries while the nebulous liar's poker game - built one cloud castle of vapor profits on top of another - kept going as long as we allowed the markets to lie to shareholders. Except in this liar's poker game, both sides of the Big Playez booked profits on different sides of the bet.

Tell me how we mark this crap to value when both sides booked profits on their bets? The House won, the players betting against the house won too.

At least for a while.

During the Mark to Market game, the dealer and the players waited for the cameras in the casino to turn off during the Mark to Market holidays. With the cameras (regulations) off, they all scooped the table clean of chips. They all won something. And they scooted out the doors to their places in the Hamptons to have some laughs over fine wines and good Scotches.

After their holidays, they'd come back to play the rigged game where everyone wins, suck some more vapor profits out of the mark to market air, and then run the table clean before their next jaunt to the Hamptons.

It worked for a while until the first blow up on Wall Street and the players and the casino dealers couldn't find a place around the crater to park their new Lexuses and Mercedes. People were late to the game. Then the house began to limit the action.

Fights broke out at the table.

Gangs of white collar bonusgrippers went from pointing fingers to throwing fists.

The Bear Stearns gang got wiped out. Their backup gang at the monolines didn't have enough gang members to come back them up during the first rumble.

Then the ratings agencies stuck their heads into the fracas, and heads rolled everywhere across the floor, and the whole casino came crashing down as one gang after another torched table after table.

It's like the saying Colin Powell used to warn Bush, "You break it, you buy it." They broke it, they bought it.

Instead of building more privatized Club Fed prisons for the people who wrecked our financial system I say one thing: let 'em die. Even if it means most Americans cannot use credit for the next ten years to buy a new car or a new house, it will force people to learn how to live below their means. Is that a bad thing? Let the casinos burn to the ground, I say. You and I aren't here on this Earth to supply jobs and booty to the money changers who destroyed our financial system.

Let the country learn a valuable lesson from this crisis: there is no functioning Capitalism in big systems without regulators enforcing tough regulations to hold sociopathic and psychopathic greedheads in place.

People who cry for pure Capitalism or pure Socialism are both coming from the same place.

They want power and they are greedy. They know that without any checks and balances from the masses they can use corrupt ways to steal the labor and honey of the masses.

We saw it in Communist Russia. We saw it in Enron. We saw it in Bulgaria. We saw it in Lehman Brothers. We see it in Cuba today. We see it on Wall Street now.

The roof, the roof, the roof is on fire. We don't need no water, let the mother trucker burn.

If all the "too big to fail" banks go under, does that mean smaller entities with real value, no overextended loans, and smart honest businessmen won't step into their shoes? If the world's economies contract, growth slows everywhere, and deflation rules in assets, does it mean we all die a horrible death?

Our grandparents made do with less after their Roaring 20s punch bowl was taken away. We can do it too. Especially Americans. We are a tough breed of people, armed to the teeth (thank you 2nd Amendment) and no Robber Barons in government, religion or business can force their views on a Nation like ours without a Revolution.

Wall Street has never listened to Main Street. This time, they've walked over the line. We the People should not listen any longer to the white collar criminals who stole our Common Wealth just so they could all live like Kings at our Nation's expense.