Mark To Market, Already!

In July, I had a breakfast meeting with two gentlemen who are quite well versed in the bond market. They asked me whether the credit situation that was just coming to light would be prolonged and would it spread elsewhere. My answer was that this was the healthy move for the credit markets given how overvalued they had become. I went on to say that I didn't think that would spread to the rest of the economy and precipitate a recession (I'm not sure my colleagues agreed with me). Up until recently I agreed with that assessment. However, in making that assessment, I assumed (that word!) that the appropriate rules and laws of trading and valuation would apply. Now I'm now so sure.

The problem with my premise is that the valuation issues that began to come to light in summer are still lingering and perhaps they are getting worse. What I mean by getting worse is story out today on Merrill Lynch that they acted in concert with hedge funds to hide or defer losses. If this is true, it is almost a certainty that that type of activity occurred elsewhere. This is a major trust issue. Let's face it, financial firms don't have vast amounts of real assets backing up their market capitalization. When trust is eliminated from the equation, value and the ability to do business dries up. There are many examples; E.F. Hutton comes to mind about a firm where the market lost confidence. It cannot be emphasized enough that all the players need to determine their exposures, value them as conservatively as possible (there were many times in my career when I marked bonds to distressed levels, even zero, if I couldn't determine the value by usual means.) or get them off the books. There is a market clearing value for everything. You would get the impression when reading/listening to the popular press that these SIV assets are worthless. That is because when it is discussed, the exposure level is mentioned implicitly as an all-or-nothing value; either a SIV is worth face value or it is worth nothing, like a coin flip. The reality is that the value is somewhere in between. It's time for the banks, brokerages, and other involved parties to move to those levels come clean about the losses and move on. Otherwise, the markets face continuing levels of volatility, slowly deteriorating week by week, trading lower on rumor and innuendo.