Wednesday, September 24, 2008

The Trouble with Marking to Market

At first read this article sounded like really good news for the economy in general and the real estate industry in particular. It's basic premise is that many banks' balance sheets look worse than they really are because of laws requiring them to 'mark to market' their mortgage holdings. After a few quarters of major write-downs most banks' balance sheets now represent a worst-case, fire-sale scenario even if they plan to hold their loans to maturity or work them out. Given the lack of volume in the secondary markets, it is often impossible to accurately mark these assets to market in the first place meaning that the write-downs we've seen so far are likely far from how things will eventually shake out. In some cases the write-downs will probably turn out to be insufficient, but in many other cases I suspect that a year from now banks will have extra capital freed when marked-down assets turn out to be more valuable than expected. Even Sam Zell points to this marking to market as a major cause of our current problems.

The bad news is that for now no one can tell what these assets are really worth so we must, by law, go with very conservative estimates. This means that even those healthy banks who don't need to fire-sale their assets look sick and will be restrained in new lending until things shake out and they know what their true balance sheets look like. This could take a while, so sit back and relax through the next few months, or if you're more proactive and sitting on a pile of cash get out there and pay top-dollar for mortgage assets and get these markets rolling again! Oh wait, I think Uncle Sam might just do that for you, that's fine...

Llenrock Group

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