David R. Henderson  

Buffett on Mark to Market

The Mankiw-Krugman Non-Bet... William Isaac is Wrong on Mark...

My favorite Wall Street Journal writer, Holman W. Jenkins, Jr., has an excellent piece today on Buffett's views of Mark-to-Market. It seconds what I quoted Less Antman saying last week and what commenter Patrick Sullivan pointed out. Sullivan linked to a debate on The Jim Lehrer Newshour between former FDIC chief William Isaac and Paul Krugman. Isaac had said:

I think those banks today are in better shape than the banks that we dealt with in the 1980s. We had 3,000 banks fail in the 1980s. And if we had -- if we had had mark-to-market accounting -- and that's where the SEC requires these banks to mark down marketable assets to whatever the current market price is -- if we had had that in the 1980s, every one of the major banks would have failed, absolutely.

Here's the key passage from Jenkins:

Now comes Warren Buffett, a big investor in Wells Fargo, M&T Bank and several other banks, who, during his marathon appearance on CNBC Monday, clearly called for suspension of mark-to-market accounting for regulatory capital purposes.
We add the italics for the benefit of a House hearing tomorrow on this very issue. Mark-to-market accounting is fine for disclosure purposes, because investors are not required to take actions based on it. It's not so fine for regulatory purposes. It doesn't just inform but can dictate actions that make no sense in the circumstances. Banks can be forced to raise capital when capital is unavailable or unduly expensive; regulators can be forced to treat banks as insolvent though their assets continue to perform.

Interestingly, according to Jenkins, CNBC left out the key part of Buffett's statement. Jenkins writes:

CNBC, sadly, has been playing a loop of Mr. Buffett's remarks that does a consummate job of leaving out his most important point. Nobody cares about the merits of mark-to-market in the abstract, but how it impacts our current banking crisis. And his exact words were that it is "gasoline on the fire in terms of financial institutions."
Depressing bank stocks today, he said, is precisely the question of whether banks will be "forced to sell stock at ridiculously low prices" to meet the capital adequacy rules.
"If they don't have to sell stock at distressed prices, I think a number of them will do very, very well."
He also proposed a fix, which CNBC duly omitted from its loop, namely to "not have the regulators say, 'We're going to force you to put a lot more capital in based on these mark-to-market figures.'"

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CATEGORIES: Finance , Regulation

COMMENTS (8 to date)
Les writes:

I wonder if the critics of "mark to market" have read the accounting standard that requires mark to market valuation of securities.

Mark to market valuation of securities applies only to securities whose estimated market value is below cost other than temporarily.

In other words, if estimated market value is below cost other than temporarily, then the securities are reported at estimated market value.

It seems to me quite evident that securities whose estimated market value is below cost other than temporarily are impaired and worth less than cost. So use cost if you want to be precisely wrong, or use estimated market value if you'd rather be roughly right.

Valuing securities whose estimated market value is below cost, at cost seems like the person falling off a 50 story building passing the 20th floor and saying "so far, so good."

Barkley Rosser writes:


I am unclear where you are coming down on this bottom line, especially as you quote pieces of Buffett's testimony. So, is using a mark to market accounting a problem in a regulatory context that imposes capital requirements and requires banks to unload assets to build up their "capital" when mark to market accounting says they are too low, with the outcome being a further driving down of market values that then pushes more banks down to have to unload assets leading to... ?

Les's remark seems not to be aware of this matter at all. Les, is the market always perfect, even in a world in which previous bubbles are crashing?

David R. Henderson writes:

Yes. That's where I'm coming down.

Les writes:


My position is in favor of mark to market for both financial reporting and capital requirements. Both should be based on the factual valuations of assets, rather than the fictions of par values or sunk costs.

You asked me if the market is always perfect. My answer is not necessarily. It is always imperfect when the government regulates it - and the financial sector is riddled with regulation.

Anunay Gupta writes:

I think its reasonable to suppress MTM rules in extraordinary situations wherein the vicious cycle of asset price depreciation and the cause for asset price depreciation feed relentlessly on each other.

This would then ask us to define what is a 'extraordinary ' situation. This is where the regulators would need to act and earn their stripes......

ws1835 writes:

The world of engineering and science has a term for this conundrum. It is called a 'negative feedback loop'. In the instance of a bank panic or market crash, the mark to market rules directly act to worsen the conditions. By maintaining the rules under these circumstances, the regulations are actually making the situation worse.

Barkley Rosser writes:


Sorry, but you are wrong. This is an example of a positive feedback loop. "Positive" in this sense does not mean "good" necessarily. In general in system dynamics, it is negative feedback loops that are stabilizing, while it is positive feedback loops that can be destabilizing (if they are too strong). Negative feedback implies the system goes against an exogenous shock to go back towards where it was. Positive feedback implies the system moving even further into the direction that it has been pushed, e.g. falling asset values combining with MTM and cap requirements to further push asset prices down even lower.

Methinks writes:

I'm getting the sense the people are conflating mark to market and allowing increased leverage in a time of crisis.

Capital requirements are merely leverage caps. Mark to market has the potential to reduce capital such that the bank is in violation of its leverage cap. So, is the better solution to mark to whatever you want or to allow more flexibility in leverage?

It seems to me that the latter is preferable to the former. Discretion in marks inevitably leads to abuse and nasty surprises. That's why we have mark to market accounting. The real purpose of eliminating the mark to market rule is to allow the banks to increase leverage without saying that the leverage is increased. Why not just be honest about the purpose without undermining transparency?

Bank assets will not be worth more because the bank has the discretion to mark them to whatever is convenient for them. Accounting does not determine the value of the assets.

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