I would love to hear your take on the mark to market debate. I have been saying for awhile now that mark to market is responsible for the steepness of this banking crisis, but obviously not the root cause itself. Do you agree that the financials and the market in general would benefit from abolition of these rules? Do you agree that this is an issue that should have been addressed months ago?
Mark to market helped the financials skyrocket in boom periods and has sunk them in this crisis.
I'm no expert on this situation, but I do have strong opinions.
1) Yes. I agree that this issue should have been resolved months ago. And must be resolved now.
2) Here's a question for you: Assume you have a large position that is short a substantial number of long-term strangles and that you have a downside bias – i.e., you are delta short. Further assume that market conditions become uncertain and implied volatility soars to record levels.
You love your position. The market declined and starting with acceptable risk, believe you are in great shape. After the market decline, you are now delta neutral and anticipate that the strangles will begin to shrink in value.
There's one little problem. The strangles you sold @ $30 when VIX (CBOE Voltaility Index) was 50, are now trading @ $180 and VIX is 120. Your account cannot take the loss of $12,000 per strangle because you sold too many. Your account is in deficit.
When your broker threatens to liquidate your account unless you wire a huge influx of cash, do you believe you can tell the broker that: "It's just marks. If we ignore mark to the market, my account is in great shape. See how neutral I am."
You know you cannot. You are over-leveraged and lost far more money than you thought possible.
How can your broker evaluate your account by any method other than mark to the market? And if you cannot repay your debt, it's their money on the line. They are going to liquidate – and probably at very unfavorable prices.
3) Thus, I'm a big believer in MTM. If the financial institutions were forced to MTM daily, it would have been obvious that they owned assets in trouble (worth less than the value carried on the bank's books), and would have been forced to begin unloading them far sooner. I don't know who would have bought these positions, but being allowed to continue to hide losses, become more and more over-leveraged, and essentially gamble with (what turned out to be) taxpayer money, is not right.
I believe MTM is essential and levels the playing field for everyone. The problem is, that it should have been enforced far sooner. We would not be in this mess (It would be a different mess) if MTM had been enforced from the beginning. Enforcing it now is going to make things more difficult. But the fact that MTM was not enforced earlier is not an adequate reason for not enforcing it now.
4) I believe several of these big banks are insolvent, will remain insolvent forever, and have zero chance of recovering. I admit that I do not fully understand the consequences, but I'm for nationalization right now.
I believe the government should take all the garbage assets (we are paying for them anyway) and create new, clean banks. Imagine Citibank with all of their assets: branches, customers, deposits, etc – and no bad loans on the books. That would be worth many, many billions of dollars – and the taxpayers would benefit as the government sold 80% of that bank (gotta retain some ownership in the new, thriving business) to new, qualified investors. Current officers, not eligible. These healthy banks would have no reason to be afraid to lend to each other, or to the public. Thus, the economy would have an increased chance of recovering quickly. Continued stalling is not going to help these banks become solvent.
One more point. I know there would be a market for all those currently toxic assets. The government could sell those positions to anyone who wanted to bid. That way, the taxpayer would no longer own them, would no longer have to throw good money after bad, and would have temporary, partial ownership in the recovering banking system.
Naive? Perhaps. But it sounds right to me.