Losses for securities were next estimated by multiplying the outstanding stock of each type of security by the change in the market price of the relevant index over the course of a year. ... Beginning with the residential mortgage market, subprime-related ABS and CDO securities were priced using ABX and TABX derivative indices, respectively. Average losses on securities were estimated as 30 percent of principal for ABS and 60 percent for ABS CDOs since last year. ... The loss estimates are subject to the following caveats and uncertainties: The fall in market prices may be overshooting potential declines in cash flows over the lifetime of underlying loans ... Based on this approach, we estimate total losses from broad credit market deterioration of $945 billion globally, $565 billion of which is due to losses on residential mortgage debt, $240 billion on commercial real estate debt, $120 billion on corporate debt, and $20 billion on consumer credit debt. Securitized debt (rather than whole loans) accounts for the bulk of losses.
...
The abnormally tight market liquidity conditions during the crisis intensified discussions on the role of fair value in contributing to its severity. ... One argument suggests that fair value is compounding market instability by applying the valuations arising from sales in these abnormal market conditions across all fair-valued portfolios, regardless of the intention of holding them. While the need for liquidity drove values to discounts that were greater than the underlying cash flows would imply, the argument challenges the appropriateness of subjecting those portfolios to mark-to-market volatility where there is no intention or need to sell at the full amount of the liquidity induced discounts. This requirement to apply fair value without considering underlying conditions may be compounding instability by activating market-value triggers for liquidation in other portfolios. Even if the markdown does not force a sale, it may trigger margin calls or additional collateral requirements that would further compound market illiquidity by reducing a firm’s supply of assets available for further liquidity operations. ... While many view fair value as the best indicator of asset value at the time of measurement, taken on its own it may not be the best measure for making long-term, value-maximizing decisions. This arises because fair value reflects a single, point-in-time exit value for the sum of all the risks the market assigns to the asset, including credit and liquidity risks. If the market overreacts in its assessment of any risk component, then fair value will reflect this. Hence, the heavy discounting during the crisis of any asset containing securitized instruments produced fair values much lower than their underlying expected future cash flows would imply, even allowing for the possible impairment of subprime elements. Situations where firms use fair value levels to trigger decision rules, such as asset sales, may produce scenarios that both generate unnecessary realized losses for the individual firm and simultaneously contribute to a downward spiral of the asset price, thus compounding market illiquidity. It is therefore evident that the weaknesses arising from the use of fair value in a crisis need to be addressed.
Sabaziotatos says:
In other words, the IMF has issued a report stating that weaknesses in fair value accounting (which includes mark-to-market accounting) in a crisis need to be addressed, and in the same report they have estimated global losses from broad credit market deterioration ($945B) by marking outstanding par value to market against indices like the ABX. This seems problematic to me.
Alan Reynolds makes the same point in a recent column in the New York Post :
- "IMF Puts Cost of Crisis Near $1 Trillion," screamed a Washington Post headline April 9. ... [W]e're talking accounting losses - many of them only temporary. These are paper losses on mortgage-related securities - taken because accounting rules require financial firms to mark the securities down to some estimated "fair value." These securities still generate ample cash from mortgages - but, as the IMF explained, "Heavy discounting during the crisis . . . produced fair values much lower than their underlying expected future cash flows would imply." That is, many such securities are likely to be written up sooner or later.
1 comment:
This phenomenon of irrational M-T-M accounting requirement has produced both disaster and opportunity. Disaster in instances like BSC and TMA where the MTM has produced margin calls leading to institutional collapse and opportunities like MBI,ABK where there are no liquidity events (although hyperactive rating agencies did produce dilutive capital raises). These observations on the stupidity of MTM being applied so braodly have been sorely lacking from the mainstream press and cable histrionics. Thanks for your great service SAB.
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