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Originally Posted by hi_im_god
actually, the dumbest thing was changing accounting rules away from mark to market so that bank balance sheets can now be what they imagine an asset will be worth when things are all better vs. what the market tells you it's worth.
i'm not an accountant and i don't have a fully developed grasp of the issue but other than "it's a category 5 sh*t storm if we don't do this", i haven't seen a good explanation for why imaginary numbers are better than real ones.
i don't know how anyone can have any faith in the numbers coming out of financial institutions after this. they're basically made up.
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I can see both sides of the issue. Let me give you an example of where mark to market accounting can put unfair stress on a financial institution. Lets say we have 80 million dollars of AAA loans marked "held for sale" in our warehouse line and we value the assets that are backing those PERFORMING loans at 100 million. ABC bank down the street just had a builder default on a big loan and they need money NOW. They sell a similar book of assets as the ones we have on our line except there is no demand right now for even AAA loans. They have no choice but to sell the 100 million dollars worth of assets off 70 million dollars. Now a new market has been set for 70 million dollars over night. Sucks doesnt it?
Whats worse? Our warehouse lender will call us the next morning for whats called an "equity call". We have to have skin in the game and our 80 million dollars in loans on the warehouse is now being backed by assets valued at 70 million dollars. We have to pay down our line until its 80% of 70 million. Thats a 24 million dollar check. On top of that, we have to have a certain amount of cash on hand. So now we need money. So what do we do? We have to sell assets QUICKLY to raise the cash and the cycle repeats.
It really is not this simple but Im trying to give you a basic understanding of what happens during a credit crunch, why banks horde cash and how mark to market can be devastating to the system.