November 4, 2008
Re: Mark-to-Market Valuations (File Number 4-573)
Gentlemen:
Thank you for soliciting public response for your study.
Your application of Mark-to-market asset valuation as applied to mortgage-backed securities was a mistake. Mark-to-market quickly became Mark-to-Panic turning a $300B real estate problem into potentially a $12T mortgage problem. The longer you wait to restore a Mark-to-Reality valuation methodology the bigger the problem will become. The paradox (see below) of decoupling the value of securities from their practical value as collateralized by real property will ultimately impact mortgages not bundled in such securities the lockup in credit caused by this mistake will mean many fewer home buyers resulting in ever lower real property valuesthe problem you created has and will continue to feed on itself.
As I describe in this series of videos: HTTP://TINYURL.COM/SOLVE-IT, no bailout would have been required had you acted quickly. There were warnings from bankers before Mark-to-Market was instituted in November of 2007 and there were louder warning immediately after. The bailout became the financial equivalent of WMD—scaring us into making a mistake by giving the government more power than necessary to make a large problem even larger.
The Troubled Asset Relief Program, or bailout bill passed by congress gave Treasury the right to purchase troubled assets (MBSs) from banks that would presumably participate in a reverse auction to determine which assets would be purchased first. However, in practice, this clearly would not work since any bank successful in selling its MBSs would be identified as one of those with the worst problems and thus make it difficult to obtain credit from other banks in the future.
Then, apparently ignoring what the bill had authorized, Treasury moved to Plan B, purchasing new stock with capital infusions totaling $125B in nine large banks, effectively nationalizing them. In theory, these funds should have allowed the nine banks to extend $1.25T in new credit. Instead, they have used those funds to go shopping for banks not fortunate enough to receive a gift. These actions do not make more money available for lending and in fact, deleverage our economy. It also means the government will be deciding which banks succeed and which fail instead of the free market.
So by not quickly fixing the Mark-to-Market mistake, it has propagated into a bailout which has propagated into gifting a select few banks with the funds to purchase assets at pennies on the dollar that will ultimately bounce back to a large percentage of their original value when you do finally Mark-to-Reality, which, indeed, you must. And why is that? Because you have created a financial paradox:
Approximately 2% of the mortgages in this country are in foreclosure, an alarmingly high number that needs to be addressed by more conservative lending practices in the future—like requiring a down payment, for example. But this means holders of MBSs are receiving, on average, 98% of their interest yet these securities have been written down to pennies on the dollar and in some cases ZERO Paradox: How can a MBS containing hundreds of millions of dollars in mortgage balances paying 98% of their interest be worth zero?
When you do finally make the correction in asset valuation rules, the gifted banks assets they purchased for pennies on the dollar will magically rebound to 98% of their original value providing huge profits for the nine banks that used our money to make these purchases instead of extending credit. Its easy to see why Mr. Paulson had no problem selling the nine banks on our investment.
Mark-to-Market needs to be revised to Mark-to-Reality. The longer you wait the messier it gets. There is no way to compensate the many people and businesses that have experienced large losses as a result of this mistake the total size of the global impact may be incalculable. Im not sure what, if any, recourse they will have. Nevertheless, restoration of our credit markets is critical for restoration of our equity markets and this wont happen until the mistake is corrected.