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As a former trading desk guy I struggle to see how the system allows things to be marked-to-cost. Or rather, why is it that we allow a bank to not mark-to-marke

As a former trading desk guy I struggle to see how the system allows things to be marked-to-cost. Or rather, why is it that we allow a bank to not mark-to-market a security for which there is a liquid market? Allowing the bank to pretend it has more assets than it actually has seems to be an invitation to hide risk. If they had to MTM their underwater bonds, they would would have been pushed to raise capital earlier, or they would have cut their losses earlier. It should be straight up "I have these deposit liabilities, I have this book of assets, oops, my assets are down a bit, lets do something about it". Instead of "I'm gonna run the gauntlet and hope the business survives until these bonds come in".

echion 4y ago
> why is it that we allow a bank to not mark-to-market a security for which there is a liquid market? Because at maturity, the bank gets back its money. So it is perfectly valid to say "in ten years, this $100m bond is worth $100m...and I intend to hold it for ten years, so it's worth $100m [equivalent] today". The "I intend to hold it" is the relevant part of the valuation, though.
- SilasX 4y ago
  The problem, though, is that it's not necessarily 100% up to them whether they'll hold it to maturity, since withdrawals can force them to liquidate it. It seems like they should have a ruling forcing the use of some formula that factors in this possibility.
- tnel77 4y ago
  Maybe both metrics would be useful. “If we had to sell today, this is our situation. If these bonds are held to maturity, this will be our situation.” Seems like that would allow an investor to see the state of the bank more clearly.
  - echion 4y ago
    Definitely. And SVB's financial reporting / balance sheet showed this problem beforehand, AIUI.
- hn_throwaway_99 4y ago
  > The "I intend to hold it" is the relevant part of the valuation, though. Yup, and definitely anticipate there will be major new regulations in this area. A huge part of SVB's book of bonds were categorized as "Hold to Maturity". And, legally, if you mark bonds as HTM, you are not allowed to hedge against their interest rate risk. Basically, the regulations say that if you're hedging against interest rate risk, you don't really intend to hold to maturity, so you need to put them in the "Available for Sale" category. The fact that SVB had such a huge book of bonds at paltry rates with no/minimal hedging is just awful risk management.
  - dragonwriter 4y ago
    > Yup, and definitely anticipate there will be major new regulations in this area. It already happened. The new regulation is that the Fed now has a liquidity backstop for banks holding this asset class, using cash loans with a set maximum term against the par value. Apparently the Fed decided “if we treat it this way for capital adequacy, and we provide liquidity backstops for banks for other asset classes based on how they are valued for capital adequacy, maybe we should do the same thing here, since otherwise adequate capital can easily and suddenly become inadequate.”
    - bryananderson 4y ago
      This backstop only applies to existing holdings. Banks can't go out today and load up on hold-to-maturity assets and expect the Fed to backstop them tomorrow with loans at par value. Presumably the next step is to regulate HTM holdings so that this won't be necessary again, or else you're creating a moral hazard.
  - daydream 4y ago
    > And, legally, if you mark bonds as HTM, you are not allowed to hedge against their interest rate risk. Basically, the regulations say that if you're hedging against interest rate risk, you don't really intend to hold to maturity, so you need to put them in the "Available for Sale" category. This seems like an important point that I haven’t seen mentioned elsewhere. Lots of folks have been like “these people are morons they didn’t hedge their crappy bonds.” Can you write more about this?
- UncleMeat 4y ago
  But the entire point of computing current assets is to understand the effects of rapid withdrawals from the bank. If you are trying to predict the future value of the bank or how much money they will make then looking at the value at maturity makes sense. But the regulatory system doesn't (or shouldn't) care about that. The regulatory system should be concerned with estimating and mitigating the risk of sudden bank failure.
  - stanleydrew 4y ago
    I believe this is what various "stress tests" are for. If your bank is a certain size you have to basically do scenario planning for situations like ”what if 25% of your deposits leave overnight and you have to sell securities that you didn't plan to sell?” As I understand the situation, SVB was just under the required size to submit to those stress tests.
    - fifticon 4y ago
      to my understanding, they themselves lobbied legislators to put them under that size (by increasing the ceiling).
    - fwlr 4y ago
      There are smaller tests for liquidity, but the specific major stress test that SVB lobbied themselves out of is the DFAST (the Dodd Frank Act Stress Test) and it does not test liquidity. It takes the scenario of an adverse economic situation and comes up with a bunch of hypothetical numbers you might see for major economic variables - “the unemployment rate will be this, the default rate will be that, etc,” - and then banks have to run their books according to those hypothetical numbers and report back what their capital would look like in that situation. If it looks bad, they have to take action to make their capital more secure. Nowhere does it simulate a situation where depositors leave en masse. There are liquidity tests and SVB was probably failing them (which is probably why the FDIC was paying close attention to them), but that specific test you’ve heard about is not related.
      - insonable 4y ago
- deleted 4y ago
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- shapefrog 4y ago
  Except the treasury desk is paying 5% to the person who gave you the $100m to buy the bond that is paying you and interest rate of 1%.
- codeflo 4y ago
  > The "I intend to hold it" is the relevant part of the valuation, though. It’s really not, at least not mathematically. That intentions play a role is purely an artifact of regulations.
  - echion 4y ago
    > > relevant > not mathematically Agreed. I don't think the GP was asking a mathematical question, so "relevant" meant "to explain why MTM accounting is not the only way".
- jasode 4y ago
  >So it is perfectly valid to say "in ten years, this $100m bond is worth $100m...and I intend to hold it for ten years, so it's worth $100m [equivalent] today". But that valuation model is not perfectly valid. It's only partially valid under limited scenarios. As many comments have already pointed out, the issue is the bank has customers with demand deposits. The customers can demand withdrawal of their money anytime -- without advanced notice. In other words, SVB is not a hedge fund that has the customers' deposits contractually locked up for 10 years. Therefore, the "10 year bond held to maturity" assumption becomes invalid if the bank has to sell them prematurely at distressed discount prices -- to meet liquidity requirements of demand deposits. You can't use value securities as "mark-to-intended-optimal-future" as an alternative to "mark-to-market" for purposes of insolvency risk calculations.
  - dragonwriter 4y ago
    > But that valuation model is not perfectly valid. It’s only partially valid under limited scenarios. Its valid under the applicable regulations. However, it is one case where having adequate capital under those rules was not backstopped by available liquidity measures from the Fed. One thing that seems to be generating less commentary is that, in the wake of the SVB collapse, and virtually simultaneously to the announcement of the systemic risk exception for SVB by the FDIC/Treasury/Fed, the Federal Reserve also announced a generally-available liquidity backstop program for this kind of hold-to-maturity assets. > You can’t use value securities as “mark-to-intended-optimal-future” as an alternative to “mark-to-market” for purposes of insolvency risk calculations. To the extent that refers to valuing the class of assets at issue at their par value, and to the extent that that was true last week, its not now.
  - s1artibartfast 4y ago
    >You can't use value securities as "mark-to-intended-optimal-future" as an alternative to "mark-to-market" for purposes of insolvency risk calculations. I think this is exactly correct, but I dont think that is the purpose and scenario reported on their financial statements. I think it is fine to report valuation in terms of "mark-to-solvent future", as long as the appropriate data is provided to enable insolvency risk calculations, and the "mark-to-solvent future" model is not presented or confused with a insolvency risk model. If an investor does not understand how HTM assets are accounted per regulation, but they are accurately reported, confusing the models is an investor error, not a bank reporting error. My understanding is that banks provide clear reporting, and are transparent with their HTM portfolio. HTM securities are typically reported as separate noncurrent assets; they have an amortized cost on a company's financial statements.
- kmod 4y ago
  Welcome to a non-zero interest rate environment. "$100m equivalent today" is not $100m -- the term to search for is "net present value". These considerations are precisely what marking to market captures
  - s1artibartfast 4y ago
    If those assets are in your hold to maturity portfolio, they are still worth $100m. This return is guaranteed unless the Federal Bank defaults on those treasuries.
    - kmod 4y ago
      $100m future dollars, which are less valuable than present dollars.
      - daveguy 4y ago
        That's hedging against inflation (which is definitely something they should have been doing for long term bonds). Interest rates directly affect the sale price of a bond, and it could have been hedged against, but it wasn't required. They won't do it unless it's required. Banks over 50 billion need to be regulated again (and they should lower it to 10 billion too).
      - s1artibartfast 4y ago
        $100m future dollars are still still $100m dollars. It is the value of the dollar that is changing, not the number of them that you hold. The day you are paid, you will still get handed exactly $100m million. Every day between now and then you will still have exactly $100m in bond holdings. How many cheeseburgers you can buy with that number of dollars may change from day to day, but the number of dollars will not.
        morelisp 4y ago
        You don't need to appeal to cheeseburgers to not want to value 100 future dollars at 100 current dollars, if you can buy 100 future dollars for 80 current dollars, which is essentially what happened when rates rose. (Someone else is offering 100 future for 80 current because they have a forecast about cheeseburgers, sure. But you don't have to agree with that forecast to take their deal; the deal looks even better for you if you don't agree.)
- OJFord 4y ago
  But why is that valid, if it's trading below par? In the extreme - obviously you can't buy a call option and say 'I intend to hold this until it's $10 in the money, so it's actually worth (time-adjusted) $10'. What's the difference, besides probabilities of outcomes?
- ars 4y ago
  Let's extend your example - I have a bond that costs $1 today, but is worth $1,000 at maturity - except that maturity is in 1,000 years. So, can the bank claim it has $1,000 now?
HWR_14 4y ago
As I understand it, banks have some assets that are marked-to-market, and others that are assumed to be held to maturity. Their classification is determined when they are purchased, but there are rules governing the mix. To some degree this makes sense, because if the maturity timelines and classification are correct the bank is only losing opportunity cost and inflation-adjusted dollars. Not actual dollars. Meanwhile, if they need money from the fed it is offered against collateral based on mark-to-market value.
bombcar 4y ago
It seems to me (being uneducated in the matter) that if a bank is holding US government debt (treasuries) as "hold to maturity" that the US Government should have some ability to offer a line of credit against those assets for cases like this one was. Or that the bank should be able to say "depositor X transferred $100 million to Chase, so we sent Chase a wire for $10 million and treasuries marked HTM worth $90 million" or something.
- s1artibartfast 4y ago
  >Or that the bank should be able to say "depositor X transferred $100 million to Chase, so we sent Chase a wire for $10 million and treasuries marked HTM worth $90 million" or something. Why? HTM bonds are not cash so they are not interchangeable. This is like if you were forced to accept a 10 year IOU in place of cash from your employer.
  - bombcar 4y ago
    Regulations that required banks (directly or indirectly) to buy government bonds should also require the banks to accept interchange of them when needed. Banks exist at the whim of the gov't, it can require things for stability.
    - s1artibartfast 4y ago
      Sure, Governments can do anything they want. They can round people up and put them in gas Chambers. I'm just saying it's a bad idea and don't think the fact that the government can do it has any bearing on if it should do it. With your proposition, I think it would be a terrible idea and reduce stability. I don't see how letting Banks unload bad assets on each other does anything to help the situation. The Bad Assets just follow the customer wherever they go and some unlucky Bank get stuck with them when the customer converts their cash to something like stocks or buys a cheeseburger. At best, you have just turned bonds into the same thing as cash, defeating the purpose of bonds to begin with. You buy a bond and are paid interest because you can't use it as cash. At worst it would be chaos. Everyone buys bonds and holds them when the value is good. When the value is bad, everyone forces each other to take over their bad Investments.
shapefrog 4y ago
You just know that all the losing trades went from the hold-to-sell-for-a-profit book to the hold-to-maturity book. In the olde days that was the bottom drawer where you would stuff the losing tickets at the end of the day and hope that they were in the money tomorrow.
ianferrel 4y ago
>Or rather, why is it that we allow a bank to not mark-to-market a security for which there is a liquid market? I agree with your main point. You'd have to be careful with regulation around this, because what you might end up with is banks preferentially seeking assets for which there is not a liquid market so they can pretend they are worth more. That's... not an obvious improvement.
timcavel 4y ago
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revel 4y ago
There are liquidity, jurisdiction and tax considerations that go into bond accounting. Under both US GAAP and IFRS you can't flip between held to maturity, available for sale and m2m asset classification advantageously. I think this is ok -- it's impractical and misleading for a bank to value every liability and asset by rebaselining value constantly. How would you determine fair value for a bespoke security anyway? No matter what you did it would be largely guesswork anyway. This change would make banks more difficult to value and increase volatility since performance would be even more heavily driven by market conditions. In my opinion, accounting statements aren't really the right place for the kind of disclosure you're looking for. The Basel accords are supposed to establish a risk-oriented way of measuring and controlling capital risk limits across asset classes. SVB and other regional banks fought heavily against being subject to this kind of oversight. I think it makes more sense to rework Basel 4 based on this failure rather than change the accounting standards.
- kmod 4y ago
  Many types of institutions have to mark to market on a ~constant basis, so it's not impossible. Yes there are certain asset classes (private companies, for example) that don't have easy or reliable marks (but people still do it anyway!). But at least for SVB the issue was not determining the market value, but that the market value was bad.
dorianG4 4y ago
The answer is simple of course, which is why no one does anything; the political and finance systems are in cahoots to enrich themselves and so such common sense policing to insure the stability of the system everyone relies on is not allowed. Finance crimes are low tech and have not evolved much as they don’t need to; there’s no policing. Have a go at it, elites scream communism and the like, and rile up the 2nd Amendment fan boys, only to throw the ones that go over the line in jail to keep up appearances. I’ve been noting and watching this same social ebb and flow since the 80s. The kids/teens then who soaked that reality up live it still today. IMO memory is why we had a mini-Reagan in Trump grow so popular. The reason such things you point out are allowed is they’ve always been allowed from the perspective of those benefiting from them. If the system was stable and accountable to the masses, the phony winners rich off mathematical inference but too inept to keep themselves alive would of course be subject to a terrible regime should elites be required to pull on their boot straps; a figurative identity of being coddled is all they know!
anonymouse008 4y ago
You know as well as I that the reason is that cash was able to sit in banks without losing money as a depositor. That gentleman's agreement is gone, due a set of actors' individualistic and uncooperative actions.
whatever1 4y ago
So in a downturn all of the banks would just seem insolvent. What is the alternative ? To have the banks trading on a millisecond basis so that the mark to market value of assets is positive ? What about the transaction fees ?
ouid 4y ago
There is a massive conflation of insolvency and illiquidity going on here, because the distinction requires more mathematical finesse than most people have. A bank is illiquid if its holdings require time to sell at "market price". Selling things like mortgages requires time because the buyer has to perform due diligence. If i have to sell mortgages right now, I'm going to be getting an awful price for them. OTOH, i can sell treasuries in a fraction of a second at the ask price minus epsilon. It's not a liquidity problem, its an assets < liabilities problem, (as you clearly state, I'm just frustrated by the discussion here).
shawndrost 4y ago
The basic job of a retail bank is to fund long-term loans with short-term deposits. A bank which is doing this optimally is still curiously vulnerable to bank runs. If all short-term deposits decide to redeem at once, that collective decision might render the bank insolvent and incapable of returning deposits at par, because not all long-term loans can be immediately redeemed/sold at par. In the normal course of business, nobody thinks too hard about this. Asking such an institution to MTM (which is intrinsically about immediate redemption/sale value) is asking everyone to document and consider a bank's inability to immediately redeem all depositors. We're doing more of that, which has pros and cons. (Recent MTM disclosures set off the SVB run in advance of a planned SVB equity fundraise.) Finance is an imaginary staircase that only works until we look down and freak out. We don't document the robustness of the stairs because the stairs aren't real.
- Scoundreller 4y ago
  > basic job of a retail bank is to fund long-term loans with short-term deposits. CDs are a thing. Unpopular because their rates sucked but that hasn’t always been the case. Long-term loans become like short term loans closer to maturity. A mature bank should have a fair amount maturing every year, mortgages 24 or 23 or whatever years ago. Along with some early repayments or reissuances from people moving. Or 4 years ago for a vehicle, etc.
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piepiethesailor 4y ago
I highly recommend watching Mark Meldrums video from yesterday that answers your question.
gumby 4y ago
> As a former trading desk guy I struggle to see how the system allows things to be marked-to-cost. Or rather, why is it that we allow a bank to not mark-to-market a security for which there is a liquid market? Many of their assets aren't really fungible either. Mortgages are the canonical example: yes they can now be turned into MBS, but your local credit union just issues and holds them). The same is true of the commercial loan to the local stationary business. As far as I know those aren't bundleable into commercial paper securities. The debtors do the same: they don't treat their loan as having any market value at all beyond what it had when issued. House prices generally don't mark to market except in places with property tax assessment.
- landemva 4y ago
  > your local credit union just issues and holds them [mortgages] I was on BoD of a CU. About the only thing we didn't resell were loans which did not conform. The business was to originate, quickly resell, and do some more.
  - gumby 4y ago
    Thanks for this info!
alexpotato 4y ago
I'm surprised no one has already mentioned this series of events: - Enron used "creative" accounting and mark to something style procedures to create fake valuations - They go out of business. - Regulators say, "Hey! Now you need to mark to market always!" - 2008 happens. Markets for things like CDOs and CDSs dry up almost overnight. At the very least most of the liquidity is gone and spreads get VERY big - B/c of the above coupled with rules of "you need to mark to market" and "if value falls X% you have to sell", lots of selling happens in low liquidity environments and therefore prices fall more, the downward cycle begins - Post 2008, people realize that "mark to market, always!" maybe isn't the best idea. - I would imagine, that's why the Govt is saying "Ok, we will pretend that your assets are worth par value". They don't want to trigger the downward spiral. It's also interesting to note that the Govt made money on many of the assets they bought in 2008 at well below par value. The implication is that those assets were undervalued when they bought them. Again, I would imagine this is a selling point of the idea "the par value is probably not that bad price to pay for these things now".
- lordnacho 4y ago
  > B/c of the above coupled with rules of "you need to mark to market" and "if value falls X% you have to sell", lots of selling happens in low liquidity environments and therefore prices fall more, the downward cycle begins This is a _good_ thing. We don't want a house of cards that's so fragile as soon as it looks like it it's going to fall down, we pour glue all over it and prop it up with cardboard. Assets need to fall in value so that the next guy can have a chance to thrive. Some bank collapsing is an opportunity for some of the younger folks to buy up a piece, or leave with a team and a book of customers. We should have this happen regularly so that it isn't an earthquake each time.
  - skybrian 4y ago
    It seems like there are limits, though. Do you really need to contribute to a flash crash [1], or is some longer time period okay? Not getting triggered by a flash crash seems more robust, and getting triggered by it more fragile? Some of the time, anyway. [1] https://en.wikipedia.org/wiki/2010_flash_crash https://en.wikipedia.org/wiki/2010_flash_crash
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NovemberWhiskey 4y ago
Isn't the short answer that if you made banks be flat interest rate delta, it would be impossible to make money as a bank - and therefore there would be no banks? If a bank that makes a mortgage loan has to buy an interest rate swap that zeros out the interest rate risk on that loan, then the replicating portfolio is basically ... nothing ... right? Banks have to be long duration risk to be useful.
- landemva 4y ago
  Banks would charge fees for services.
bhgtopt 4y ago
Talking about the detail is wasting the effort when the problem is located at higher level, which is, the whole system is built in a socialism territory, started when Gold is by planning (major element of socialism), taken away from banking industry.
amluto 4y ago
> It should be straight up "I have these deposit liabilities, I have this book of assets, oops, my assets are down a bit, lets do something about it". Instead of "I'm gonna run the gauntlet and hope the business survives until these bonds come in". Have a read of Matt Levine: https://archive.is/l4nLU https://archive.is/l4nLU The “let’s do something about it” could actually be business as usual. Look at the “deposit beta” in that article: when interest rates increase, mean rates banks pay on deposits increase less. So you can have a bank with a low mark-to-market value (assume all deposits liquidate at par and securities are sold at mid-market), but that ignores the value of the enterprise itself. Or you can project forward (to a specific time or times, not necessarily to the arbitrary maturity of each security), and you may well find that you end up with enough money at every point in the future to be quite comfortable, assuming your deposits stick around and continue to earn less than market interest. Imagine you worked at a magic trading desk where you could issue a very special bond: you borrow money right now, and you pay a floating interest rate that is set at 1/2 the federal funds rate. This is a great deal, but it comes with a catch: the bond holder can call the debt at any time, which they will do on occasion at random but will do en masse if they don’t like you. Also, people can lend you money on these terms and you have to accept the deal. How would you make money on these? How would you account for them? I agree that HTM accounting, done carelessly, can lead to wrong conclusions.

echion 4y ago

> why is it that we allow a bank to not mark-to-market a security for which there is a liquid market? Because at maturity, the bank gets back its money. So it is perfectly valid to say "in ten years, this $100m bond is worth $100m...and I intend to hold it for ten years, so it's worth $100m [equivalent] today". The "I intend to hold it" is the relevant part of the valuation, though.

SilasX 4y ago
The problem, though, is that it's not necessarily 100% up to them whether they'll hold it to maturity, since withdrawals can force them to liquidate it. It seems like they should have a ruling forcing the use of some formula that factors in this possibility.
tnel77 4y ago
Maybe both metrics would be useful. “If we had to sell today, this is our situation. If these bonds are held to maturity, this will be our situation.” Seems like that would allow an investor to see the state of the bank more clearly.
- echion 4y ago
  Definitely. And SVB's financial reporting / balance sheet showed this problem beforehand, AIUI.
hn_throwaway_99 4y ago
> The "I intend to hold it" is the relevant part of the valuation, though. Yup, and definitely anticipate there will be major new regulations in this area. A huge part of SVB's book of bonds were categorized as "Hold to Maturity". And, legally, if you mark bonds as HTM, you are not allowed to hedge against their interest rate risk. Basically, the regulations say that if you're hedging against interest rate risk, you don't really intend to hold to maturity, so you need to put them in the "Available for Sale" category. The fact that SVB had such a huge book of bonds at paltry rates with no/minimal hedging is just awful risk management.
- dragonwriter 4y ago
  > Yup, and definitely anticipate there will be major new regulations in this area. It already happened. The new regulation is that the Fed now has a liquidity backstop for banks holding this asset class, using cash loans with a set maximum term against the par value. Apparently the Fed decided “if we treat it this way for capital adequacy, and we provide liquidity backstops for banks for other asset classes based on how they are valued for capital adequacy, maybe we should do the same thing here, since otherwise adequate capital can easily and suddenly become inadequate.”
  - bryananderson 4y ago
    This backstop only applies to existing holdings. Banks can't go out today and load up on hold-to-maturity assets and expect the Fed to backstop them tomorrow with loans at par value. Presumably the next step is to regulate HTM holdings so that this won't be necessary again, or else you're creating a moral hazard.
- daydream 4y ago
  > And, legally, if you mark bonds as HTM, you are not allowed to hedge against their interest rate risk. Basically, the regulations say that if you're hedging against interest rate risk, you don't really intend to hold to maturity, so you need to put them in the "Available for Sale" category. This seems like an important point that I haven’t seen mentioned elsewhere. Lots of folks have been like “these people are morons they didn’t hedge their crappy bonds.” Can you write more about this?
UncleMeat 4y ago
But the entire point of computing current assets is to understand the effects of rapid withdrawals from the bank. If you are trying to predict the future value of the bank or how much money they will make then looking at the value at maturity makes sense. But the regulatory system doesn't (or shouldn't) care about that. The regulatory system should be concerned with estimating and mitigating the risk of sudden bank failure.
- stanleydrew 4y ago
  I believe this is what various "stress tests" are for. If your bank is a certain size you have to basically do scenario planning for situations like ”what if 25% of your deposits leave overnight and you have to sell securities that you didn't plan to sell?” As I understand the situation, SVB was just under the required size to submit to those stress tests.
  - fifticon 4y ago
    to my understanding, they themselves lobbied legislators to put them under that size (by increasing the ceiling).
  - fwlr 4y ago
    There are smaller tests for liquidity, but the specific major stress test that SVB lobbied themselves out of is the DFAST (the Dodd Frank Act Stress Test) and it does not test liquidity. It takes the scenario of an adverse economic situation and comes up with a bunch of hypothetical numbers you might see for major economic variables - “the unemployment rate will be this, the default rate will be that, etc,” - and then banks have to run their books according to those hypothetical numbers and report back what their capital would look like in that situation. If it looks bad, they have to take action to make their capital more secure. Nowhere does it simulate a situation where depositors leave en masse. There are liquidity tests and SVB was probably failing them (which is probably why the FDIC was paying close attention to them), but that specific test you’ve heard about is not related.
    - insonable 4y ago
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shapefrog 4y ago
Except the treasury desk is paying 5% to the person who gave you the $100m to buy the bond that is paying you and interest rate of 1%.
codeflo 4y ago
> The "I intend to hold it" is the relevant part of the valuation, though. It’s really not, at least not mathematically. That intentions play a role is purely an artifact of regulations.
- echion 4y ago
  > > relevant > not mathematically Agreed. I don't think the GP was asking a mathematical question, so "relevant" meant "to explain why MTM accounting is not the only way".
jasode 4y ago
>So it is perfectly valid to say "in ten years, this $100m bond is worth $100m...and I intend to hold it for ten years, so it's worth $100m [equivalent] today". But that valuation model is not perfectly valid. It's only partially valid under limited scenarios. As many comments have already pointed out, the issue is the bank has customers with demand deposits. The customers can demand withdrawal of their money anytime -- without advanced notice. In other words, SVB is not a hedge fund that has the customers' deposits contractually locked up for 10 years. Therefore, the "10 year bond held to maturity" assumption becomes invalid if the bank has to sell them prematurely at distressed discount prices -- to meet liquidity requirements of demand deposits. You can't use value securities as "mark-to-intended-optimal-future" as an alternative to "mark-to-market" for purposes of insolvency risk calculations.
- dragonwriter 4y ago
  > But that valuation model is not perfectly valid. It’s only partially valid under limited scenarios. Its valid under the applicable regulations. However, it is one case where having adequate capital under those rules was not backstopped by available liquidity measures from the Fed. One thing that seems to be generating less commentary is that, in the wake of the SVB collapse, and virtually simultaneously to the announcement of the systemic risk exception for SVB by the FDIC/Treasury/Fed, the Federal Reserve also announced a generally-available liquidity backstop program for this kind of hold-to-maturity assets. > You can’t use value securities as “mark-to-intended-optimal-future” as an alternative to “mark-to-market” for purposes of insolvency risk calculations. To the extent that refers to valuing the class of assets at issue at their par value, and to the extent that that was true last week, its not now.
- s1artibartfast 4y ago
  >You can't use value securities as "mark-to-intended-optimal-future" as an alternative to "mark-to-market" for purposes of insolvency risk calculations. I think this is exactly correct, but I dont think that is the purpose and scenario reported on their financial statements. I think it is fine to report valuation in terms of "mark-to-solvent future", as long as the appropriate data is provided to enable insolvency risk calculations, and the "mark-to-solvent future" model is not presented or confused with a insolvency risk model. If an investor does not understand how HTM assets are accounted per regulation, but they are accurately reported, confusing the models is an investor error, not a bank reporting error. My understanding is that banks provide clear reporting, and are transparent with their HTM portfolio. HTM securities are typically reported as separate noncurrent assets; they have an amortized cost on a company's financial statements.
kmod 4y ago
Welcome to a non-zero interest rate environment. "$100m equivalent today" is not $100m -- the term to search for is "net present value". These considerations are precisely what marking to market captures
- s1artibartfast 4y ago
  If those assets are in your hold to maturity portfolio, they are still worth $100m. This return is guaranteed unless the Federal Bank defaults on those treasuries.
  - kmod 4y ago
    $100m future dollars, which are less valuable than present dollars.
    - daveguy 4y ago
      That's hedging against inflation (which is definitely something they should have been doing for long term bonds). Interest rates directly affect the sale price of a bond, and it could have been hedged against, but it wasn't required. They won't do it unless it's required. Banks over 50 billion need to be regulated again (and they should lower it to 10 billion too).
    - s1artibartfast 4y ago
      $100m future dollars are still still $100m dollars. It is the value of the dollar that is changing, not the number of them that you hold. The day you are paid, you will still get handed exactly $100m million. Every day between now and then you will still have exactly $100m in bond holdings. How many cheeseburgers you can buy with that number of dollars may change from day to day, but the number of dollars will not.
      - morelisp 4y ago
        You don't need to appeal to cheeseburgers to not want to value 100 future dollars at 100 current dollars, if you can buy 100 future dollars for 80 current dollars, which is essentially what happened when rates rose. (Someone else is offering 100 future for 80 current because they have a forecast about cheeseburgers, sure. But you don't have to agree with that forecast to take their deal; the deal looks even better for you if you don't agree.)
OJFord 4y ago
But why is that valid, if it's trading below par? In the extreme - obviously you can't buy a call option and say 'I intend to hold this until it's $10 in the money, so it's actually worth (time-adjusted) $10'. What's the difference, besides probabilities of outcomes?
ars 4y ago
Let's extend your example - I have a bond that costs $1 today, but is worth $1,000 at maturity - except that maturity is in 1,000 years. So, can the bank claim it has $1,000 now?

HWR_14 4y ago

As I understand it, banks have some assets that are marked-to-market, and others that are assumed to be held to maturity. Their classification is determined when they are purchased, but there are rules governing the mix. To some degree this makes sense, because if the maturity timelines and classification are correct the bank is only losing opportunity cost and inflation-adjusted dollars. Not actual dollars. Meanwhile, if they need money from the fed it is offered against collateral based on mark-to-market value.

bombcar 4y ago

It seems to me (being uneducated in the matter) that if a bank is holding US government debt (treasuries) as "hold to maturity" that the US Government should have some ability to offer a line of credit against those assets for cases like this one was. Or that the bank should be able to say "depositor X transferred $100 million to Chase, so we sent Chase a wire for $10 million and treasuries marked HTM worth $90 million" or something.

s1artibartfast 4y ago
>Or that the bank should be able to say "depositor X transferred $100 million to Chase, so we sent Chase a wire for $10 million and treasuries marked HTM worth $90 million" or something. Why? HTM bonds are not cash so they are not interchangeable. This is like if you were forced to accept a 10 year IOU in place of cash from your employer.
- bombcar 4y ago
  Regulations that required banks (directly or indirectly) to buy government bonds should also require the banks to accept interchange of them when needed. Banks exist at the whim of the gov't, it can require things for stability.
  - s1artibartfast 4y ago
    Sure, Governments can do anything they want. They can round people up and put them in gas Chambers. I'm just saying it's a bad idea and don't think the fact that the government can do it has any bearing on if it should do it. With your proposition, I think it would be a terrible idea and reduce stability. I don't see how letting Banks unload bad assets on each other does anything to help the situation. The Bad Assets just follow the customer wherever they go and some unlucky Bank get stuck with them when the customer converts their cash to something like stocks or buys a cheeseburger. At best, you have just turned bonds into the same thing as cash, defeating the purpose of bonds to begin with. You buy a bond and are paid interest because you can't use it as cash. At worst it would be chaos. Everyone buys bonds and holds them when the value is good. When the value is bad, everyone forces each other to take over their bad Investments.

shapefrog 4y ago

You just know that all the losing trades went from the hold-to-sell-for-a-profit book to the hold-to-maturity book. In the olde days that was the bottom drawer where you would stuff the losing tickets at the end of the day and hope that they were in the money tomorrow.

ianferrel 4y ago

>Or rather, why is it that we allow a bank to not mark-to-market a security for which there is a liquid market? I agree with your main point. You'd have to be careful with regulation around this, because what you might end up with is banks preferentially seeking assets for which there is not a liquid market so they can pretend they are worth more. That's... not an obvious improvement.

timcavel 4y ago

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revel 4y ago

There are liquidity, jurisdiction and tax considerations that go into bond accounting. Under both US GAAP and IFRS you can't flip between held to maturity, available for sale and m2m asset classification advantageously. I think this is ok -- it's impractical and misleading for a bank to value every liability and asset by rebaselining value constantly. How would you determine fair value for a bespoke security anyway? No matter what you did it would be largely guesswork anyway. This change would make banks more difficult to value and increase volatility since performance would be even more heavily driven by market conditions. In my opinion, accounting statements aren't really the right place for the kind of disclosure you're looking for. The Basel accords are supposed to establish a risk-oriented way of measuring and controlling capital risk limits across asset classes. SVB and other regional banks fought heavily against being subject to this kind of oversight. I think it makes more sense to rework Basel 4 based on this failure rather than change the accounting standards.

kmod 4y ago
Many types of institutions have to mark to market on a ~constant basis, so it's not impossible. Yes there are certain asset classes (private companies, for example) that don't have easy or reliable marks (but people still do it anyway!). But at least for SVB the issue was not determining the market value, but that the market value was bad.

dorianG4 4y ago

The answer is simple of course, which is why no one does anything; the political and finance systems are in cahoots to enrich themselves and so such common sense policing to insure the stability of the system everyone relies on is not allowed. Finance crimes are low tech and have not evolved much as they don’t need to; there’s no policing. Have a go at it, elites scream communism and the like, and rile up the 2nd Amendment fan boys, only to throw the ones that go over the line in jail to keep up appearances. I’ve been noting and watching this same social ebb and flow since the 80s. The kids/teens then who soaked that reality up live it still today. IMO memory is why we had a mini-Reagan in Trump grow so popular. The reason such things you point out are allowed is they’ve always been allowed from the perspective of those benefiting from them. If the system was stable and accountable to the masses, the phony winners rich off mathematical inference but too inept to keep themselves alive would of course be subject to a terrible regime should elites be required to pull on their boot straps; a figurative identity of being coddled is all they know!

anonymouse008 4y ago

You know as well as I that the reason is that cash was able to sit in banks without losing money as a depositor. That gentleman's agreement is gone, due a set of actors' individualistic and uncooperative actions.

whatever1 4y ago

So in a downturn all of the banks would just seem insolvent. What is the alternative ? To have the banks trading on a millisecond basis so that the mark to market value of assets is positive ? What about the transaction fees ?

ouid 4y ago

There is a massive conflation of insolvency and illiquidity going on here, because the distinction requires more mathematical finesse than most people have. A bank is illiquid if its holdings require time to sell at "market price". Selling things like mortgages requires time because the buyer has to perform due diligence. If i have to sell mortgages right now, I'm going to be getting an awful price for them. OTOH, i can sell treasuries in a fraction of a second at the ask price minus epsilon. It's not a liquidity problem, its an assets < liabilities problem, (as you clearly state, I'm just frustrated by the discussion here).

shawndrost 4y ago

The basic job of a retail bank is to fund long-term loans with short-term deposits. A bank which is doing this optimally is still curiously vulnerable to bank runs. If all short-term deposits decide to redeem at once, that collective decision might render the bank insolvent and incapable of returning deposits at par, because not all long-term loans can be immediately redeemed/sold at par. In the normal course of business, nobody thinks too hard about this. Asking such an institution to MTM (which is intrinsically about immediate redemption/sale value) is asking everyone to document and consider a bank's inability to immediately redeem all depositors. We're doing more of that, which has pros and cons. (Recent MTM disclosures set off the SVB run in advance of a planned SVB equity fundraise.) Finance is an imaginary staircase that only works until we look down and freak out. We don't document the robustness of the stairs because the stairs aren't real.

Scoundreller 4y ago
> basic job of a retail bank is to fund long-term loans with short-term deposits. CDs are a thing. Unpopular because their rates sucked but that hasn’t always been the case. Long-term loans become like short term loans closer to maturity. A mature bank should have a fair amount maturing every year, mortgages 24 or 23 or whatever years ago. Along with some early repayments or reissuances from people moving. Or 4 years ago for a vehicle, etc.

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piepiethesailor 4y ago

I highly recommend watching Mark Meldrums video from yesterday that answers your question.

gumby 4y ago

> As a former trading desk guy I struggle to see how the system allows things to be marked-to-cost. Or rather, why is it that we allow a bank to not mark-to-market a security for which there is a liquid market? Many of their assets aren't really fungible either. Mortgages are the canonical example: yes they can now be turned into MBS, but your local credit union just issues and holds them). The same is true of the commercial loan to the local stationary business. As far as I know those aren't bundleable into commercial paper securities. The debtors do the same: they don't treat their loan as having any market value at all beyond what it had when issued. House prices generally don't mark to market except in places with property tax assessment.

landemva 4y ago
> your local credit union just issues and holds them [mortgages] I was on BoD of a CU. About the only thing we didn't resell were loans which did not conform. The business was to originate, quickly resell, and do some more.
- gumby 4y ago
  Thanks for this info!

alexpotato 4y ago

I'm surprised no one has already mentioned this series of events: - Enron used "creative" accounting and mark to something style procedures to create fake valuations - They go out of business. - Regulators say, "Hey! Now you need to mark to market always!" - 2008 happens. Markets for things like CDOs and CDSs dry up almost overnight. At the very least most of the liquidity is gone and spreads get VERY big - B/c of the above coupled with rules of "you need to mark to market" and "if value falls X% you have to sell", lots of selling happens in low liquidity environments and therefore prices fall more, the downward cycle begins - Post 2008, people realize that "mark to market, always!" maybe isn't the best idea. - I would imagine, that's why the Govt is saying "Ok, we will pretend that your assets are worth par value". They don't want to trigger the downward spiral. It's also interesting to note that the Govt made money on many of the assets they bought in 2008 at well below par value. The implication is that those assets were undervalued when they bought them. Again, I would imagine this is a selling point of the idea "the par value is probably not that bad price to pay for these things now".

lordnacho 4y ago
> B/c of the above coupled with rules of "you need to mark to market" and "if value falls X% you have to sell", lots of selling happens in low liquidity environments and therefore prices fall more, the downward cycle begins This is a _good_ thing. We don't want a house of cards that's so fragile as soon as it looks like it it's going to fall down, we pour glue all over it and prop it up with cardboard. Assets need to fall in value so that the next guy can have a chance to thrive. Some bank collapsing is an opportunity for some of the younger folks to buy up a piece, or leave with a team and a book of customers. We should have this happen regularly so that it isn't an earthquake each time.
- skybrian 4y ago
  It seems like there are limits, though. Do you really need to contribute to a flash crash [1], or is some longer time period okay? Not getting triggered by a flash crash seems more robust, and getting triggered by it more fragile? Some of the time, anyway. [1] https://en.wikipedia.org/wiki/2010_flash_crash https://en.wikipedia.org/wiki/2010_flash_crash

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NovemberWhiskey 4y ago

Isn't the short answer that if you made banks be flat interest rate delta, it would be impossible to make money as a bank - and therefore there would be no banks? If a bank that makes a mortgage loan has to buy an interest rate swap that zeros out the interest rate risk on that loan, then the replicating portfolio is basically ... nothing ... right? Banks have to be long duration risk to be useful.

landemva 4y ago
Banks would charge fees for services.

bhgtopt 4y ago

Talking about the detail is wasting the effort when the problem is located at higher level, which is, the whole system is built in a socialism territory, started when Gold is by planning (major element of socialism), taken away from banking industry.

amluto 4y ago

> It should be straight up "I have these deposit liabilities, I have this book of assets, oops, my assets are down a bit, lets do something about it". Instead of "I'm gonna run the gauntlet and hope the business survives until these bonds come in". Have a read of Matt Levine: https://archive.is/l4nLU https://archive.is/l4nLU The “let’s do something about it” could actually be business as usual. Look at the “deposit beta” in that article: when interest rates increase, mean rates banks pay on deposits increase less. So you can have a bank with a low mark-to-market value (assume all deposits liquidate at par and securities are sold at mid-market), but that ignores the value of the enterprise itself. Or you can project forward (to a specific time or times, not necessarily to the arbitrary maturity of each security), and you may well find that you end up with enough money at every point in the future to be quite comfortable, assuming your deposits stick around and continue to earn less than market interest. Imagine you worked at a magic trading desk where you could issue a very special bond: you borrow money right now, and you pay a floating interest rate that is set at 1/2 the federal funds rate. This is a great deal, but it comes with a catch: the bond holder can call the debt at any time, which they will do on occasion at random but will do en masse if they don’t like you. Also, people can lend you money on these terms and you have to accept the deal. How would you make money on these? How would you account for them? I agree that HTM accounting, done carelessly, can lead to wrong conclusions.