Marking bank loans to market

By Felix Salmon
May 28, 2010
FASB's proposed rule change, which Tracy Alloway calls "mark-to-mayhem".

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Should banks mark their loans to market? The issue — which flared up briefly at the height of the financial crisis, when everybody was wondering whether many of America’s largest banks were insolvent — is back in the headlines, thanks to FASB’s proposed rule change, which Tracy Alloway calls “mark-to-mayhem”.

Cue the predictable response from the American Bankers’ Association:

If implemented, the proposal would greatly undermine the availability of credit by making it difficult to make many long-term loans, the value of which, even if performing perfectly, would likely be reduced on the day a loan is made.

As a curio, before the financial crisis, banks’ fair value numbers were generally above book value. At that point no one really seemed to care about the discrepency, or mark-to-market, for that matter.

It’s not obvious just how much mayhem the proposed rule change would cause, since Businessweek’s Michael Moore says that “changes in the fair value of loans probably wouldn’t show up in banks’ earnings”. But I’m not completely convinced that this is a good idea.

In general, I’m all in favor of transparency in the reports of public companies in general, and banks in particular. So if banks are forced to reveal the true value of their assets, that’s good. But it’s not good if it just results in effective bank runs, where banks with low-value loans found themselves shut out of the repo markets, for example.

It’s certainly true that when any individual bank — like Goldman Sachs, for example — starts marking its assets to market, that imposes a very useful discipline and can help that bank avoid large losses: when the loans start dropping in value, they get dumped sharpish.

But that’s much easier for Goldman Sachs than it is for commercial banks with enormous long-term loan books and valued relationships with their borrowers. What’s more, it would be disastrous if every bank in America started dumping its loans every time they fell in value — given that they would all be sellers rather than buyers, the value of the loans would plunge enormously overnight, and then they really would all be insolvent.

My feeling is that so long this is just an extra reporting requirement, and it doesn’t show up on the income statement or the balance sheet, we’re probably fine. Banks should certainly be marking their loans to market internally, and if they’re doing that it makes sense to ask them to report those marks to their shareholders on a quarterly basis. But there is a real risk here, if those shareholders start to panic when they see the marks.


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It’s all about information. The lender collect a fee for his work collecting the information when you establish the loan. If you want to sell it (which is MtoM), the buyer has to do the same work, and of course wants to pay you your book value of the loan minus his costs (if he is smart and do not do business based on “trust me”). It is just like buying a new car, the value drops when you sign the contract. Trust me.

Posted by Gaute | Report as abusive

Internally? Marking their loan portfolio internally serves no real purpose. Do you believe they would cut back on leverage if banks used those ‘internal’ numbers.

The banks have become the enemy. You suggest they would start dumping the loans as they lose value. I suggest they would make fewer low quality loans. That’s good for everyone.

Felix: The next time you get a margin call from your broker, tell them it’s not important to mark to the market, and according to your internal figures, there is no need for a margin call. See where that gets you.


Posted by MarkWolfinger | Report as abusive

So what if shareholders panic! It that worries management so much then they should manage their business more carefully. All this would be much less of an issue if more banks had managed their loan books better. Keeping the common shareholder in the dark does not solve the problem of bad bank management, or that even some good banks get in trouble because their well-managed loan books get degraded in value by the problems of others. All it does is keep some intelligent investors in the dark.

Felix, I know you are well-intentioned in your concern about us poor common retail investors. But we are not all complete idiots and we do not need to be protected from ourselves all the time or even from the scoundrels on Wall Street. Surviving as an individual investor is a process of survival of the fittest. You either learn to fend for yourself in the markets or you get out and turn it over to someone else. Most of us who have been at it for a while have learned to stick to the turf each of us as an individual is comfortable with. None of us learn that without having the opportunity to lose some money first.

If I were you I would worry a lot more about those institutions that are managing big piles of money for ordinary people. Too many of those institutions are not as smart as they think and are big fat easy prey for the market predators.

Posted by wpw | Report as abusive

“If implemented, the proposal would greatly undermine the availability of credit…”

FYI, “availability of credit” is a misnomer these days, when small businesses are concerned .
We are in the same “credit crunch” situation, we were three years ago.
And BTW, we already know the big banks are insolvent, don’t we? This is why they had to change the accounting rules.

Posted by yr2009 | Report as abusive

I think it’s generally accepted that most of the major financial institutons were and still are insolvet as of the meltdown. It would just be fun to get them to admit it in writing!

Posted by Woltmann | Report as abusive

Marking to market is also a big problem for insurers since their business model is very long-term. Mark to market “profits” don’t really make much sense in that context. However, one cannot argue against the transparency and risk management benefits of MtM.

Disclosing MtM figures of long-term loans will have the same effect regardless of whether they lie somewhere in the footnotes or they are directly incorporated in the income and/or B/S statements. The trick is getting the capital requirements correct to mitigate some of the potential drawbacks of full disclosure.

Posted by yrautca | Report as abusive

wpw, you forgot the commonly used secret option number 3:

Collect your profits in the good years and when your crazy overleveraged bet blows up then sue the sell-side for “mis-selling” the product you thought paid well above the risk-free rate but was risk-free….

As for the buyside, you are absolutely right. It is not they are necessarily incompetent but rather they are incentized to take risks with your money because weirdly they seem to be able to disclaim away any fiduciary responsibility for running your money.

Posted by Danny_Black | Report as abusive


I don’t get the logic behind your view:

“In general, I’m all in favor of transparency in the reports of public companies in general, and banks in particular. So if banks are forced to reveal the true value of their assets, that’s good. But it’s not good if it just results in effective bank runs, where banks with low-value loans found themselves shut out of the repo markets, for example.”


You should elaborate upon your views. They’re unclear.

Why should MtM accounting be suspended?

Posted by dedalus | Report as abusive


Either you want transparency or you don’t.

It cannot be that you be transparent when things are great and not when they suck.

How long do you want this extend and pretend to continue?

Wall street banksters (with the able and agile connivance of the Fed and Treasury) walk away with undeserved bonus …

If transparency begets bank runs .. so be it after all it also means they deserve to go bankrupt

Schemers in the Fed and Treasury should be hosed!!

Posted by killben | Report as abusive

In practice, what you’re about to see is the TBTF banks doing partial surveys of their loan landscape and hawking the bits they no longer want to Treasury. You will never see the entire topography any more than will the banks’ shareholders and of course, there’s always the taxpayer, who gets to see least of all. Least of all that all, of the taxpayer’s own money. It’s all going to the banks, doing work that even the most dissolute of gods would be ashamed to contemplate.

Posted by HBC | Report as abusive

“My feeling is that so long this is just an extra reporting requirement, and it doesn’t show up on the income statement or the balance sheet, we’re probably fine”

It will show up on the balance sheet, but not the income statement. Basically, (most) changes in the fair value of loans held to maturity will show up in other comprehensive income, but not the profit and loss. What’s interesting is that they’ve very deliberately taken a different approach to IASB, which takes that information out of the face of the balance sheet entirely, requiring it to be disclosed in footnotes. Convergence is looking increasingly distant at this point.

Posted by GingerYellow | Report as abusive

@MarkWolfinger: Yes, at least some banks will respond internally to internal valuations.

Felix, part of the trouble here has been where banks attempt to hedge their credit risk in the CDS market, where they are required to mark the CDS to market but not the loan it was supposed to be hedging. There has at various times in the last several years — they seem to change these rules from time to time — been an option to designate certain positions as hedges, in which case they don’t have to be marked to market. This naturally opens up some room for shenanigans, but so does treating economically equivalent (or very similar) positions differently.

There’s a continuum of different degrees of liquidity and transparency in market prices. I know that DE Shaw and Goldman have both owned wind farms at various times in the last five years; those are hard to get market prices for. If you’re hedging them with more liquid instruments, those are easier to get prices for, but the whole point is that the value of those instruments should correlate negatively with the value of the illiquid asset; your net worth is less volatile than would be suggested by marking the liquid assets to market and not the illiquid ones. This leads you, eventually, to more of a mark-to-model, where your model assumes that things that correlate negatively will continue to do so. So the only definite conclusion I can give is that you’re not going to find a system that’s perfect; hopefully you can formulate a system with enough of these problems in mind that it doesn’t make any of them too bad.

Posted by dWj | Report as abusive