Mark-to-Market is Not as Simple For Banks as is Assumed

Writing about home mortgages issued between 2006-08 in his 2019 memoir What It Takes, Blackstone Group co-founder Stephen Schwarzman recalled that something north of 90% of them ultimately performed. Schwarzman’s recollection comes to mind in thinking about Cato Institute co-founder Ed Crane’s view that banks can and should mark their assets to market. Crane isn’t calling for force on the matter as much as he feels mark-to-market is what banks should do to maintain the honesty of balance sheets that he contends are fraudulent.

On its face, it’s difficult to argue with Crane, though in my case I tell Crane that regardless of whether actual banks mark to market, investors surely do. They have to, or at least they have to try to. The changing daily price of equities reflects this truth.

Still, there are arguably problems with marking to market, and Schwarzman’s observation shows why. Looking back to 2008, it’s no revelation that investors (feverishly trying to mark-to-market) were very skeptical about the mortgages on the books of banks. This is markets at work. Still, marking all 15-year mortgages to market at the time arguably would have been as fraudulent of an exercise as not doing so. Crane would likely agree. 

To understand why, anecdote will be used. Crane and I both know an individual who was paying off a 15-year mortgage in 2008 after having purchased a house in 2003. There was never any question about this individual’s ability to make good on his debts, only for him to finish paying off his mortgage in 2018 after having never missed a payment. This is notable in the sense that probably more than a few mortgages issued in 2003 ultimately defaulted. More specifically, it’s no reach to suggest that the market for 15-year mortgages in 2008 was a little bit shaky. Assuming a bank sold one 15-year mortgage off of its books in 2008, it’s not unreasonable to speculate that the bank would have taken a haircut.

All of the above is important simply because Crane’s argument is that banks should account right away for losses, including those on assets they intend to hold to maturity. In which case proper accounting in 2008 would have called for banks to write down all mortgages on their books based on the market for them at the time. A failure to do so is the source of what Crane contends is fraudulent accounting. Yet the always current mortgage of the individual we both know perhaps exposes a flaw in the argument.

This individual’s mortgage once again performed. So did most mortgages, including those issued in the frothiest mortgage years. Which means mark-to-market in 2008 would have once again painted a false picture. This rates stress given Crane’s oft-stated and very correct assertion that economies are individuals. So true, but mark-to-market calls for marking income streams paid by individuals as uniform despite them not being uniform.

Considering business loans more broadly, how would a bank mark a loan to the local furniture store? No doubt there are comps, but again, businesses aren’t uniform. Since they aren’t, there’s no real way to precisely value loans to businesses.

Which means short of banks acting as warehouses for money (in which case depositors would pay banks as opposed to being paid), there’s no surefire way to value assets. Or is there? One option would be for banks to only own highly-liquid Treasuries, but that would just push risk outside of banks. Or would it? Silicon Valley Bank largely owned 5-year Treasuries.

It’s a long way of musing that what works in theory, arguably doesn’t in practice. After which, it arguably doesn’t matter? Investors know. Writing about Lehman Brothers, Schwarzman noted that its “real estate portfolio was a mess.” Which is the point. Investors mark to market as best they can because they have to. And since they do, it really doesn’t matter what banks do.

Originally published at RealClear Markets. 


  • John Tamny

    John Tamny is a popular speaker and author in the U.S. and around the world. His speech topics include "Government Barriers to Economic Growth," "Why Washington and Wall Street are Better Off Living Apart," and more.

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