Question/Comment: If real estate is indeed the basis of our current economy, surely we cannot let it free fall. Could property prices be temporarily “set” at the value of the total mortgage on the property? And on any new property sale, if the property is mortgaged then the extent of the mortgage would determine the minimum price for which that property could be sold? There would still be foreclosures, but the total wealth would not be in the free fall that it currently is. Thank you for listening. I’d really like to know how you see this.
Paul Solman: How can you set a minimum price on something? If no one would pay the price, what would it mean to “set” it?
Only if we put this question in a slightly different way does it make any sense: Suppose, FOR PURPOSES OF ACCOUNTING, we allow financial institutions to PRETEND that housing is worth as much as the mortgages taken out against it. That is, say a bank has a billion dollars in mortgage-backed securites (see our stories here AND here to remind yourself what these are).
Unfortunately, the houses against which the mortgages were originally written now have a MARKET price of only HALF a billion. Technically, the mortgages have lost some half their value, right? Say the bank only has half a billion in capital: its own money, that is. Technically, if the bank had to act as if it had lost half a billion on its investment by “marking” the securities “to market” (i.e., the market price), the bank would now be wiped out.
But under a proposal like yours, if the bank could still keep the mortgage-backed securities on its books at their face value by NOT “marking to market,” the bank wouldn’t have to officially acknowledge its loss. Or maybe acknowledge it only slowly, over time, hoping the market would come back in the interim.
Indeed, I think this IS what’s going to happen. Under normal circumstances, “marking to market” is a way of keeping financial institutions honest. (The alternatives are known as “marking to model” – valuing assets according to your own computer model – or “marking to myth,” which is self-explanatory). But are these normal circumstances? Oh no, they’re not.
The main objective out there these days is calming things down, preventing panic, buying time. Eliminating the “mark to market” rules would help do just that.