Saturday, March 14, 2009

Some of you wanted to know what Mark-to-Market is, so here goes:

Mark-to-Market is an accounting rule adopted in Oct 2007. It is called FAS Rule 157 and required financial firms to price mortgage-backed securities at the price where they could sell them overnight. This "fire sale pricing" was the ONLY reference point for the bank. It forced them to write down loans well below value, even if they were going to hold the asset until maturity. Remember the bank is still receiving interest on the loan and most likely will until maturity. It was put in place to add transparency in the market and to avoid another Enron.

It is one of those obscure rules that had terrible unintended consequences. Say for example you had an asset on your books of an $800,000 loan with LTV of 80%. You could loan out money based on this asset, maybe make 6 $100,000 loans--keeping sufficient equity/capital in reserve and receive interest payments. This is what banks have always done. This keeps the money rolling over and the economy moving. BUT, if that asset is valued at only $400,000, you can only loan $300,000 or less because of the equity/capital requirements. Now they needed to raise capital because they had to maintain a certain ratio of capital to liabilities.

You can see where the banks couldn't loan money, why they were so devalued, and why they are holding onto the money they received. Add in FEAR and PANIC and you have the "Law of Unintended Consequences," which happened with the run on IndyMac and after Lehman Bros. failed--a horrible financial meltdown which we will continue to feel for years.

Remember, this is only my interpretation. Best to talk to your lender for details, clarification, etc.

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