A 20 minute lecture on how mark-to-market nearly wrecked the economy

[BaalChatzaf]

Please  see and learn from this lecture which explains  the 2008 meltdown and how mark-to-market accounting nearly wrecked the economy.

 

 

[merjet]

While mark-to-market accounting and the Federal Reserve's low interest rates were part of the cause of the financial crisis, the whole truth is more complicated. Much of the cause was the federal government's affordable housing policies which began during the Clinton administration. Other contributing factors were the securitized mortgages -- also extremely hard to value -- with off-balance sheet accounting and the government-created monsters named Fannie Mae and Freddie Mac. I read several books and many news stories about the crisis as it unfolded and after. If I were to recommend reading about the financial crisis, my top-ranked book would be Peter Wallison's Hidden in PlainSight.  He devotes one chapter to mark-to-market accounting. Simplified mark-to-market accounting came about partly because securitized mortgages pools with lots of slicing and dicing of the cash flows and risks were so difficult to value.  

[BaalChatzaf]

2 hours ago, merjet said:

While mark-to-market accounting and the Federal Reserve's low interest rates were part of the cause of the financial crisis, the whole truth is more complicated. Much of the cause was the federal government's affordable housing policies which began during the Clinton administration. Other contributing factors were the securitized mortgages -- also extremely hard to value -- with off-balance sheet accounting and the government-created monsters named Fannie Mae and Freddie Mac. I read several books and many news stories about the crisis as it unfolded and after. If I were to recommend reading about the financial crisis, my top-ranked book would be Peter Wallison's Hidden in PlainSight.  He devotes one chapter to mark-to-market accounting. Simplified mark-to-market accounting came about partly because securitized mortgages pools with lots of slicing and dicing of the cash flows and risks were so difficult to value.  

Bond tranches  are Frankensteinian.  A piece from here and a piece from there.   There is no way to determine a tranche price  rationally. 

[merjet]

13 hours ago, BaalChatzaf said:

Bond tranches  are Frankensteinian.  A piece from here and a piece from there.   There is no way to determine a tranche price  rationally. 

I believe that's overstated. During the first several years after tranching of mortgage pools began, pools contained a small number of tranches, such as four, and the mortgages were backed explicitly or implicitly by government guarantees. The guarantee made the security practically default-free. The tranches were not as easy to model and hence value as traditional bonds, but the task was doable. However, as years passed the tranches on new pools became way more complex, such as more than 100 tranches in some pools, involved more default risk, and more so-called recovery risk (after housing prices plummeted making the mortgages "under water"). These conditions made the modeling and rational pricing determination more Frankensteinian.