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Mark to Market?

Sometimes there’s a phrase out there, repeated over and over in the business news, but rarely explained, “mark to market” being the latest. In a course I took as part of an MBA curriculum, I learned what this meant as it pertained to futures contracts. Say you buy a contract for 100oz of gold (I’ll use $900/oz to keep the numbers simple) and for the current value of $90,000 you must put up a margin, say 10% or $9,000. At the end of each trading day the broker will mark the contracts contain in the trading account to the closing prices and either credit the account if there’s a gain or require more funds be required if the balance has fallen.

Now, this is certainly a simple task for a contract that trades on multiple exchanges at a volume that indicates willing buyers and sellers. A single mortgage is less straightforward. It requires knowing the principal (easy) current home value (not really easy) and financial condition of the borrower (which of course can change in an instant.) In theory, when one creates a pool of mortgages written according to my Mortgage 101 rules, with enough mortgages combined into one simple pool, the value of that pool should be easy to calculate. It’s a bond that starts with a 30 yr life, but whose curve is shaped a bit different as many (actually most, in normal times) will be paid off early due to refinances or sales of the property.

We now find that Mortgage 101 was ignored completely, and default rates have skyrocketed. The result of this is that the value of groups of these mortgages cannot be determined, or at least not quickly. Therefore, the concept of ‘mark to market’ becomes difficult if not impossible to implement. These mortgage pools have some value, to be sure, but the credit markets are frozen and no one seems willing to provide a market in these toxic assets. Consider, so long as a house is in decent shape, as would be most homes still occupied, the value of its underlying mortgage should be no less than the value of the house, not the 10 to 15 cents on the dollar that some investors are offering to buy these mortgages. In the end, there is simply no market for these securities to to be marked to.


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