The Bank of England and the Failure of Mark to Market

The Bank of England and the Failure of Mark to Market

Trading Features / Strategies from Simon Denham of Capital Spreads.

So. The Bank of England is finally doing what it should have done six months ago. Time will tell if the delay has been fatal (it was for Northern Rock).

The great and the good have sat on their hands since the turn of the year hoping that their problems would just go away, neatly mirroring the current political climate. It is tempting to ask ‘where have all the real leaders gone’? All we hear of now are ‘focus groups’, ‘inclusion’, ‘consensus’ and ‘consultation’, never “a hard, unpopular, decision must be taken, I am the man/woman to take it”.

For all of the brains working on the problem nobody seemed able to come up with anything other than the blindingly obvious, accept mortgage collateral versus cash. The European Central Bank and Federal Reserve have been taking this route for many months whilst the BOE sat back and let the events weaken our domestic banks and building societies. I find it doubtful whether the mere loosening of the money markets will now bring confidence back to the housing market.

Sentiment is now falling and whilst mortgage approvals have been suffering this is not the end (or even beginning) of the story. Viewings and enquiries at Estate Agents have been recording ever lower numbers. The mortgage offer is generally one of the last factors in a house purchase, first comes the hunt. As I have commented before, the real test will come if the employment outlook begins to seriously weaken. It must be something of a worry to policy makers that the current anguish is being felt when we have virtually full employment. What on earth will happen if (when) good high earning jobs start to be lost! And on that note, whilst people outside of the City of London like to smile at every misfortune felt by the absurdly overpaid bankers the fact is that in doing so they are laughing at themselves. Weakness in the City would mean an ever widening circle of misery.

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The actions of the BOE may loosen the credit markets temporarily but they are unlikely to make much difference to the levels of suspicion prevalent between the major lenders. Official announcements that there are possibly almost a trillion dollars of poor credit to write off do nothing to help. Only about 250 billion has been declared so far! So every institution is looking over its books trying to work out who is in difficulties and who is not.

The ridiculous requirement for banks to mark to market every single asset they hold is playing havoc. Most investments are in very liquid easily priced holdings (stocks, government bonds, cash etc) but many are in completely illiquid BUT perfectly secure assets (mortgage bonds, property, credit derivatives etc). How do you value a product which has good solid worth but for which, temporarily, there is no buyer? Many are being forced to revalue at ruinous levels simply because the auditors (fearful of their own backs) are insisting that this is ‘prudent’. None of them would ever dream of selling at these valuation levels but this is academic.

It is this ‘mark to market’ requirement that is likely to hold back recovery. As soon as a mortgage is awarded the lender may have to mark the loan immediately at a substantial loss!! You can understand their reluctance!

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'The Bank of England and the Failure of Mark to Market' edited by SD, updated 17-Apr-08

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