Liars’ Lexicon – Mark to Market


by David Malone

I thought it was time to draft another entry in the Liars’ Lexicon.  This time let’s look at Mark to Market vs Mark to Model, a dual item which divides opinion and upon which a very great deal hangs.

Mark to Market versus Mark to Model; or as I would put it, telling the truth versus lying through your teeth.  Neither one is very hard.

Mark to Market, also known as ‘fair value accounting’, is straightforward.  To value an asset you simply look at what you could sell it for today on the open market.  What could be simpler?  It’s an objective measure that everyone can see.  Mark to Market, even its detractors agree, provides a transparent and public way of seeing who is solvent and who is not.  Which is precisely why the banks detest it and tirelessly argue instead for the comforting opacity of Mark to Model.

Mark to Model requires a computer, someone to program it, access to all the bank’s commercially sensitive and secret data about its assets, a cast-iron agreement that none of the confidential data will be made public, and because of the foregoing, a whole lot of faith and trust in the output of the secret model and the confidential data fed into it.

It is an unexplained mystery, therefore, how it came to be that in 2007, of all years, Mark to Market was adopted by the International Accounting Standards Board (IASB) and its American counterpart, the Federal Accounting Standards Board (FASB).  It is a lot less of a mystery why Mark to Market was suddenly suspended in favour of Mark to Model.

The downward spiral argument

From the moment the banks realized, sometime in 2008-09, that sub-prime was despite assurances not ‘contained’, the banks spared no effort or expense in a campaign to have the new Mark to Market rule suspended.  Bankers and their friends argued that Mark to Market was too simplistic, did more harm than good and was responsible for much of the damage of the financial crisis.  Funny how, according to the bankers and their pals, it wasn’t defaulting loans or fraudulent CDOs, but a bad accounting rule, that was ‘really’ causing the crisis.

Here, from an article in Forbes from January 2009, is a clear exposition of some of the banking lobby’s main arguments against Mark to Market.  I chose this particular article because it was one that seemed to have an influence at the time and was quoted by others.

If you’re interested here is a follow up article by Newt Gingrich, the darling of US Libertarian ‘no government is good government’ Contract with America which quotes Wesbury and Stein’s article and expands on the same arguments.

Brian Wesbury and Robert Stein were senior economists at First Trust Advisers, an American Asset Management firm.  Mr Wesbury was a regular writer for Bloomberg and appeared frequently on CNBC.  Mr Wesbury had also been an advisor to the Joint Economic Committee of the US Congress and in 2008 stated confidently in an interview that the US was not in recession and that it was a good time to buy stocks.  But don’t let that put you off.  He has a PhD and everything.

Anyway, in 2009 he and Robert Stein wrote in their article entitled, “Mr President, Suspend Mark to Market”, that,

What many people do not realize is that mark-to-market accounting existed in the Great Depression and, according to Milton Friedman, was an important reason behind many bank failures …

A killer double whammy already.  In one sentence they frighten us with the dark spectre of the Great Depression and then, as if to save us from it, immediately reveal the holy light of the great Friedman.

The authors, and their hero Milton Friedman, argued that if banks are forced by Mark to Market rules to mark their assets to a falling market, they get drawn in to a downward spiral.  The market looks at the falling valuation of the banks and sells shares in those banks and the assets they hold.  This depresses the value of the banks and their assets.  To maintain the legal minimum requirement of capital holdings, the banks which are in trouble are forced to sell assets in order to get liquid cash.  Because they are selling, in what amounts to a fire sale, the price is pushed further downward.  Other banks, possibly even ones not yet in trouble but holding similar assets, are forced to mark them to the new and declining market value.  This forces those other banks into trouble as the value of their assets evaporates and they too have to sell.  The market becomes glutted with sellers and the prices accelerate downward.

Does this happen?  Yes it does.  And so, as the authors go on to argue,

As long as these assets have the potential to be marked down, bank capital is at risk. And as long as bank capital is at risk, private investors will remain skeptical and banks will remain conservative, which impinges their willingness to lend.

The key in the last quote is the word “potential”.  Get rid of the “potential” for those assets to “be marked down” and by this argument at least, you solve the problem.  No ‘potential’, no panic.  But note the ‘slight of mind’ here.  The authors don’t say the “potential” for the assets to in actual fact become worth less than they were, but the potential for their paper value to be ‘marked down’.

In other words, for the authors, we don’t worry about actual worth, only about what number is marked down in the accounts.  And that is the difference between Mark to Market and Mark to Model.  One says there is a real world and in it are real values and it is these which are most important.  They are what count, especially in a crisis when real things might just have to be sold to pay real debts in order to avoid real insolvency.

Mark to Model, on the other hand, says as long as we maintain confidence in paper values then we won’t have to sell and there won’t be any losses.  And if there’s aren’t any losses, then no one will be insolvent and there won’t be any crisis.   And that has been the logic of our financial leaders and the people whose interests they have so faithfully served.

Mark to Model is what has shaped our entire response to this crisis.

But while Mark to Model obviates the need for valuations and sales it does not, because it cannot, stop losses when they do occur.  And since real losses do still occur, Mark to Model needs a source of cash to support its steadfast refusal to value or sell anything.  If the banks won’t value let alone actually sell anything, lest in so doing they reveal how little their assets are worth, then they will need some other source of cash to pay the losses they suffer.

And that is why TARP and other bail outs had to be passed.  Not selling assets is fine as long as someone agrees to fund all your losses and ongoing cash needs.  Bailing out the bank’s real, actual losses with public money is the stinking underbelly and unspoken cost and consequence of the Mark to Model policy.

That is why I take umbrage when the Mark to Model proponents claim  their policy of ‘saving’ the banks and also ‘saving us’ the ruinous cost of bank collapses and defaults.  What they don’t ever mention is the cost, now bankrupting whole nations, of paying the bankers’ real losses.

Sure, bank ‘assets’ are no longer having their value destroyed by people ‘irresponsibly’ asking what they would be worth if they had to be sold, because with the taxpayer funded bail outs and government purchases that question is no longer relevant, is it?

What is still relevant, however, and still a problem for the ‘deny and pretend’, Mark to Model policy is that we are being bankrupted and our civil society is being savaged in order that the banks can play pretend.

So that is my reply to the downward spiral argument against Mark to Market.

The mis-pricing argument

The other argument against Mark to Market and in favour of Mark to Model, is that the market does not price rationally in boom or bust.  In boom times the market exaggerates how much assets are worth and in bust times it underestimates.  Both of which I think are very likely to be true.

This second argument against Mark to Market finds those who at any other time and in any other forum, would praise and worship the rational perfection of the market, would insist that markets are the best way to price anything and state with the zealot’s certainty that this rational pricing is why we should leave things to the market – suddenly arguing that the market is not so rational after all.  An astonishing about face.

The authors wheel out premiere league support to take up this argument,

Sheila Bair, current chairman of the FDIC, recently said, “we don’t have really any rational pricing right now for some of these asset categories.”  So why should banks be forced to mark these assets to market?

Here we have the amusing spectacle of free marketeers forced to claim that markets are wonderfully rational at all times except when it counts.  Suddenly the market mechanism is like the weather forecast, wonderful at forecasting sunny days in mid summer but couldn’t tell you which way was up at any other time.

By this argument the markets are essentially manic depressive.  What Keynes famously called the market’s “animal spirits” are in fact a bipolar swing, back and forth from unreasonable exuberance to irrational depression with only a brief passage in between when some semblance of clarity dawns.  No wonder we have a regular rhythm of boom and bust.  And this is the hidden hand into whose trembling grip everything should be privatized and to whose lurching operation we should leave our future?

Good idea!

But, if this is how it is, then surely we should agree that Mark to Market, for all its common sense simplicity, would only make a stupid and unstable system even worse?  We may not like it but perhaps we have no choice?

And just to give the anti Mark to Market side a really fair shake of the stick let’s add in the final argument for their side which I am sure you have all heard trotted out – that many ‘exotic’ or ‘hard to value’ assets just can’t be valued by the market because there really isn’t a market for them.  These exotic, ‘hard to value’ assets such as synthetic CDOs are hugely complex and usually sold only once, to be held to maturity, often out of sight, in off-shore SPVs and are rarely re-sold.  For all these reasons it is ‘very hard’ to value these products, especially in a falling market.  Mark to Market will just not work for them.  They can only really be valued at close to the face value for which they were originally sold.  Which is convenient verging on the miraculous!

So to summarize, we cannot Mark to Market because the market overestimates values in the boom times, exaggerating the unfounded optimism of the upswing, and underestimates values in the bust, making that too worse than it has to be.  On top of which, half the time, for the bulk of the assets out there no one in the market has any reliable idea what anything is worth because none of it was designed to be re-sold and there is therefore not much of a market out there in which to find their value.  At which point you can tell there has been genuine genius at work to make this ‘device’ that just cannot be defused.

Of course, say the bankers and their friends, don’t worry, the answer to all these problems is to Mark to Model.

Stop struggling and accept it … The banks create a model which values the assets based on all sorts of comforting sounding expert complexities.  The model doesn’t over or under estimate.  It doesn’t get itself into a spiral and ignores those who do.  The model is rational, doesn’t imperil anyone’s bank capital and best of all is impervious to political and popular meddling.  You see how easy it is when you just relax and trust those who know better.  And of course we can see they really do know better than us because they are richer.

So, who makes these models?  Well, the banks do.  After all, they are the only ones who know what these ‘assets’ have in them and how they were made in the first place.

Couldn’t we still know how they work so we could understand for ourselves?  Well, actually no, that would be a problem.  You see if the banks told us how their models worked it would reveal far too much of what the assets were and someone might be able to work out what they might be worth on the open market.  Which would put us back to square one.

This was the same reason why we weren’t allowed to know how the famous bank Stress Tests worked.  If they’d told us how the tests were done we might have seen that the banks were actually not as healthy as the tests declared them to be.  In fact we might have concluded that the banks were insolvent.

And therein lies my first problem.  The Stress Tests are, to my mind, a great and clear example of why Mark to Model is nothing but a scam.

The Stress Tests in America and later in Europe were a farce.  Nobody trusted them and nobody was reassured, because the banks did not allow any Stress Test to be created that might show them as failing.  The exact same thing happens with Mark to Model accounting.  The banks make sure any model they build and use does the job the banks need done.  And what is that job?  Well it is to erase any pricing uncertainty by the simple stroke of showing how the assets and the banks holding them are fine.  Just exactly like the Stress Tests.

For two years the banks have used Mark to Model accounting and the models have shown what the Stress Tests confirmed, that all the banks are absolutely fine and solvent.  And yet though, at the same time, the big banks have made massive ‘surprise’ losses, the US regional banks continue to go bust every week and European banks in Ireland, Portugal and Greece and the Cajas in Spain are all on ECB life support.

Asking the banks to model the worth of assets that ‘must’ be shown to be valuable otherwise the banks die, is likely to only have one outcome.  There will be a natural competitive pressure on all banks to have their model ‘calculate’ the worth of their assets as just a little higher than their competitor’s model did for theirs.  As high as possible in the boom market and as far from the bottom in the bust.

It isn’t a matter of trust.  It’s a matter of survival.  Asking the Banks to not lie about the worth of their assets is like asking bubonic plague to be fair and nice.  Fair doesn’t come in to it.  It’s in its nature to infect you, turn your own defences against you, run riot and leave you bleeding and covered in sores, as it moves on to infect another victim.  Trust me, I’m a viral infection!

The bank Stress Tests are a recent working example of how banking ‘self valuation’ does not and will not work.  The only way it ever would, is if Mother Teresa and Albert Einstein had had a secret love child and this saintly genius created and policed all the models.

Well what about the fact that some assets don’t have a market and can’t be priced?

I put this to a banker friend of mine.  He laughed.  We make these ‘assets’ complex, hard to price and therefore rarely re-sold, precisely so that they can’t be valued and will always be hidden away in off-shore SIVs.  That is the point of it all, he said.  We deliberately make things that can’t be priced, because then who can come back at you and say you mis-sold us a ‘sack of shit‘, even if someone leaves a silly memo admitting it, as JP Morgan apparently did?

My answer, to the ‘oh so hard to value exotic assets’ argument, is simple and straightforward.  Don’t make assets you can’t value.  There is no imperative for making ‘too-exotic-to-price’ assets.  So don’t make them.  And if you make them anyway, then it is your problem not ours.  Dont bleat about it afterwards.

Mark to Market is the perfect mechanism to make sure that banks do not saddle us all with ‘assets’ which cannot be valued or re-sold: the sort of toxic and unstable fraud-friendly assets for which the market is so fragile that if a cricket farts the whole thing seizes up and we have to bail out the entire shit heap.

Mark to Model is what is keeping the banks alive.  Without it they would die.  We are not keeping good banks from being destroyed in the heat of a sudden, panic sell-off at fire sale prices.  That story might have washed in ’08, but it is nearly three years later.

If the banks and their assets cannot now stand being valued on the market they need to die to rid us of their festering lies and fraud.

Mark to Model has allowed the big banks to hide their insolvency from us and from those who invest in them.  As Kathleen Barrington, one of Ireland’s best and most honourable financial journalists, showed recently, the Mark to Model rules allowed banks like UniCredit to take ‘assets’ that if valued on the market would have been savaged because no one wants them, and simply move them to another column where they can be valued at face value.  An asset that no one wanted to buy and whose value was open to question, simply by being moved to the ‘Not for sale – Hold to maturity’ column, suddenly becomes a valuable ‘model’ asset and the bank looks pink and rosy.

To conclude, this is from Zerohedge quoting a senior banker who was chief of the FDIC under Reagan writing about what a terrible thing Mark to Market, otherwise known as fair value accounting, is.

At some large banks, their loans’ fair value is billions of dollars less than their carrying amount.

That would dramatically reduce their shareholder equity—or assets minus liabilities—if the loans had to be carried at fair value.

As Zerohedge concluded,

Simply said, if everyone knew the truth, everyone would be insolvent.



Read David Malone’s Liar’s Lexicon – The List

Repo –                     Liar’s Lexicon
Volatility  –                Volatility – the market god, slayer of nations
Toxic assets –           Toxic assets – a taste
Debt laundering  –     Debt Laundering and theft
Leverage  –              Cash, Debt and the magic of Leverage
Short Selling –           Short Selling – end game guide
Speculation –            Specualtion and Bubbles
Securitization –          Securitization – The Undead heart of the Shadow banking machine – Part 1
The Undead Heart – part 2
The Undead Heart – part 3
Inflation –                  Inflation deflation
Mark to Market –        Liar’s Lexicon – Mark to Market


David Malone is the author of the book Debt Generation. You can read and listen to excerpts from his book here: