Monday, February 23, 2009


The "market value" of these assets are the function of two variables: the cash flow and the discount rate. Clearly many assets are impaired due to cash flows. However, the asset values are also plunging due to an increase in the hurdle rate "the market" is requiring to hold them.

Let's say you are the senior loan officer of Omniscient National Bank, and every loan in your loan portfolio is performing-- and you are such a good underwriter that every loan is expected to pay back 100%. Good, you are safe, right? Noooo...

Suppose the market just decided it wants a 15% return to hold loans of your type, instead of the 7% it required before. The value of your portfolio is now 50% lower, and you are insolvent. Sheila Bair will be there Monday to close you down.

Seems unfair, doesn't it? Suspending MtM is not a solution to the cash flow problem, it is a solution to the arbitrary discount rate problem, which can cause capital violations and potential insolvency despite no egregious actions on the part of the lenders. FAS 157 must be repealed; or at least suspended, immediately.

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