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Commentary

Mark-To-Paulson – A game with loaded dice

Jonathan Weil thinks there’s more to this deal – in terms of a mark-to-market scandal. See “Why Mark-to-Paulson Accounting won’t save banks“:

The plan goes like this: Treasury will pay financial institutions above-market prices for garbage assets nobody else wants. Then, through the magic of mark-to-Paulson accounting, everybody else that owns similar stuff will use those same prices, or marks, to value the trash on their own balance sheets.

Shazam! Banks and insurance companies write up the asset values on their books. They post big profits. Their capital goes up. Everyone gets fooled. And nobody knows the difference.

So Weil says that while it sounds like that – the plan gets derailed just because we know about the plan. And the brouhaha about using reverse auctions to “discover” prices for illiquid assets, isn’t likely to work.

Under Paulson’s plan, Treasury would hold so-called reverse auctions for financial institutions’ troubled assets. Whoever submits the lowest bid gets to sell its junky assets to Treasury for cash.

While that might look like a competitive, free-market mechanism, it’s not. Once the first bid in the first auction is submitted, it may not go much lower, and it probably will be much higher than the true market value.

That’s because the real incentive for the banks isn’t to sell their rubbish to Treasury and get cash. It’s to watch the Treasury pay grossly inflated prices to others. That way, they can use those transactions for accounting purposes to mark their books to the Treasury’s farcical market prices.

Effectively – all the banks need is a better mark-to-market price to be able to have lower writedowns and in some cases, write-ups!

Why should the treasury spend $700 billion then – might as well spend a couple million, put up a few prices, and then tell everyone – forget marking to market, you can mark to Paulson instead.

And interestingly enough, when people know about this kind of rigmarole, how will it work?

I am now slowly coming to think that perhaps this bill isn’t going to be passed very soon.

  • Anonymous says:

    >Deepak

    The real incentive for the banks is to be able to sell this trash for cash and not to mark them up on the books like u mentioned.

    Where does the problem lie? Its not in what losses banks are booking. The probelm is liquidity and thats what the Fed is opening up.

    How does it matter at what price u mark the book if nobody is buying it.