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My instinct is that there are better ways than mark-to-market, because M2M will require continual adjustment, complication and volatility. There's a lot to be said for keeping a system simple and straightforward. Minimize the points of failure and you minimize the possibility for mistakes.

Shouldn't a bank be sophisticated enough to do adjust? Sure. Just like a driver should be able to drive in bad weather. But we know that bad weather causes more accidents, even among good drivers.

In this respect, isn't the SVB failure mostly a failure due to the government's policy of inflation? SVB took measures to compensate, and maybe they were too blasé about it, but at a basic level what happened here is that people who got a helicopter drop of money put it in the bank. This blew up the bank and forced them to buy lots of low interest bonds. Then, the depositors started withdrawing money faster than the bank managed its bond portfolio in the face of rising interest rates.

Should a good bank be able to navigate that situation? Probably. But it's obviously a challenging condition for banking. To follow the metaphor, it's a patch of ice that someone was going to hit.

So maybe what we should be thinking about, rather than dramatically changing banking regulations, is changing our policy choices to something more sustainable than "monetize the debt and give away as much money as the federal government possibly can".

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Mark to market is only volatile if banks take overly risky positions and fail to hedge them. What we want is for banks to take some risk (or else why bother having banks) but, given government guarantees, to have those risks well understood by regulators who are in a position to restrain excessive risks. Mark to market is a necessary tool for that regulatory purpose.

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RemovedMar 15, 2023·edited Mar 15, 2023
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Hedging a 30-year mortgage is hard. The best hedge is callable long-term debt. Something like a 10-year bond, callable after 5 years. You need the call protection to cover the borrower's option to refinance and pay off the mortgage if interest rates fall.

Freddie, Fannie, and other regulated entities have been able to hedge all of their mortgage purchases. The question of who is on the other side of their hedges is certainly interesting. We might find out that it ends up in unregulated entities that can blow up in unpleasant ways.

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Mark-to-market accounting can cause problems for non-financial companies. Suppose I bought $10 million worth of equipment 5 years ago. It might be machine tools or a lithography machine or a fleet of busses or whatever, but it's tangible capital assets that I use to produce goods or services. Suppose I expect the equipment to last 10 years, so I've been sticking $1 million in bonds per year as a sinking fund for the replacement. If interest rates go up enough, mark-to-market accounting reduces the value of my bonds and might make my company seem insolvent, even though the bonds are as good for their purpose as they ever were. I'm fine, because my long-term assets aren't backing short-term liabilities. Actually, my position has improved a bit since the next batches of bonds will be cheaper.

Financial regulators are constantly having to choose between making rules that work for financial institutions and hoping they don't screw up the real economy too much, making rules that work for real companies and hoping they don't screw up the financial system too much, and making two sets of rules and trying to police the borders between the domains.

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It seems that in the real world the interest risk would result from rapid changes up or down in interest rates. If we look at Real Interest rates (rate - inflation) the variation in inflation drives the variation in nominal interest rate.

With absolute inflation becoming high the variance of that rate would be larger and can rapidly shift the markets for assets creating real risk. A lower risk point is found at lower absolute inflation where the absolute variation is lower.

For real world investments to make sense they must have a positive real rate of return. However within the finance system negative real interest rate loans can be profitable when loaned to another finance company but all that churn just generates paper profits, there is no real profit to the country in terms of real assets that generate real income.

As long as the Feds allow inflation to create a negative real interest rate the focus of the finance system becomes dumping money in less negative paper investment not in real investments like factories or solar farms or solar grade silicon factories or equipment or infrastructure. Just gaming the financial system and ultimately the citizens.

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I feel your experience with the S&L debacle is making you focused too much on one part of the problem. As far as I can see, the issue is just as much a kind of quantum superposition of two different income streams, which we are forcing to collapse into a single valuation. If no depositors are going to ask for their money back before the asset which we have bought with their money matures at par, then valuing that asset based on present value of future cash flows (including redemption at par at the end of the period) is appropriate. In contrast, if they all want their money back today, then obviously market value is appropriate. Yet, there is a spectrum of cases in between, nearly all of the time these are the ones that matter, and there is a mix of investment horizons among the depositors, but we are forced to pick either a present value or a market valuation, and both are wrong for all those cases. The HTM distinction is definitely open to abuse, but I see it as a crude way to try to address the weird dichotomy between valuation methods and to allow responsible banks to better value the mix of their liabilities. (Of course if an irresponsible bank shovels much of their assets into the HTM bucket even though they know that their liabilities all have short terms, all bets are off.) Your insistence that we use market value for all assets is assuming that all liabilities are due today. With that assumption banking isn't a useful activity.

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I know nothing of hedge accounting specifically, but it sounds to me like the issue is the somewhat unique risks banks take on vs other entities. The Trading/AFS/HTM categories that exist under GAAP are meant to apply across industries, and there's an obvious rationale for these categories existing. Constantly marking securities to market and running the gains and losses through the income statement for, say, a hospital or a university with big endowments funds would tend to present a distorted picture of the organization's financial results. If the hospital holds a portfolio of bonds and the value of them tanks due to a rise in interest rates, the hospital is unlikely to actually sell the bonds and realize a big loss today unless they have some strange, urgent need for capital. They're more likely to hold those bonds, ya know...to maturity, hoping to get back the face value rather than 80 cents on the dollar or whatever the market value is today.

Obviously, that's not the case for a bank. As you wrote a few days ago, a financial institution can't afford to hang onto bonds that are paying significantly below the market rate of interest, or they wind up with a negative interest spread until short term rates come back down (if they come back down). But they can still take advantage of HTM security classifications in the meantime, just like the hospital. If "Alf" is right about how hedge accounting works, you could make a decent case that that should change. It's worth pointing out here, though, that banks still disclose the fair value of all their investment securities in the notes to the financial statements, regardless of classification. You just have to go digging for it.

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Mark to market makes assumption about the asset value at a given point in time, but credit risk, the borrowers ability to make repayment in full may be unchanged. Now in the real estate markets where cap rates have risen and clearly the changes underway in real estate markets suggest that creditworthiness of a given borrower or for that matter at the macro level impairment is the case and reserves should be taken.

Such was not the case with SVB as the obligor, the USG should we hope be able to repay in full at maturity.

This was classic case of borrow short, lend long and proper matching of assets/liabilities would have likely resulted in no problem at all. Buying assets with deposits that are very short term, Tbills, etc also would have resulted in far less risk, and of course less profit from the spread.

Deposits should not fund long term assets; that seems to be quite clear and would result in depositor protections, or deposit taking function of banks should be separated from risk taking function and taking on duration risk is a risk so long as we wish to assess the financial worthiness of an institution at any point in time

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Presumably the new owners of svb will take a lesson or at least regulators will

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