There is a term that is going to become to new buzz in the current Wall Street crisis... and it is...
Mark-to-Market
Simply put, it is the the valuation of assets that a particular institution holds. Let's say that a bank holds 1,000 shares of a stock called PU, and the per share price is $13.666. It would be quite obvious that the asset is worth $13,666. It makes absolute sense. The banks SHOULD know the value of the assets that they hold.
But there are some questions in Mudville...
Real estate. The same rules are supposed to apply to real estate that is an asset to a bank (or mortage holder). They have a loan out of the property, and it is only logical that they should know the value of the underlying property. But that leaves questions...
- What value should be assigned to the property? The price it could fetch in 30 months? 30 days? 30 hours? These are radically different numbers.
- How should the value be assigned? Keep in mind that this isn't for houses that are foreclosed... this is for EVERY LOAN that the banks might have... almost EVERY HOUSE IN THE COUNTRY.
- How often should this value be updated? Once a year? Quarter? Month? Daily? We see neighborhoods that the price is moving all over the map...
In effect, these could be deal killers for the Mark-to-Market model. It is a great theory, but the practice could kill the very thing is serves to protect.
And now a word from our sponsor(s)...
I want to interject a couple of people in here. Each is brilliant, and I trust the judgement of each of these individuals. And yet, I don't see them agreeing. Matt Heaton, that's right, one of the Rain|Guys is a opinionated finance geek. And his insights are nothing short of brilliant... and I do NOT agree with him on Mark-to-Market. If you are not subscrided to and reading Matt's blog, you are shorting yourself. Ken Cook is also a brilliant writer, and a secret combatant in the war against mortgage fraud. He has insights into this that are simply lacking in many mainstream writers. And he doesn't hold back.
Back to the show...
Let's talk about the individual points above...
The biggest and potentially ugliest part of Mark-to-Market is what value to assign a property. Let's follow along with the current thought...
- Properties need to be valued at "Fire Sale Prices." Honestly, for the intent of the rule, nothing else makes sense... it is supposed to be the price the property could be sold at to quickly raise capital.
- Because the Mark-to-Market Value (M2MV) represents what the bank can recapture from the asset, it would be the max loan value... after all, that is all they can get back, it should be all they can put out...
- In neighborhoods where new buyers would likely NOT be able to come up with big down payments, the M2MV would get very close to the "retail" value of the property... 3-5% below.
- If the "retail" price is only 3-5% above the M2MV, it isn't a fire-sale price any more... and so the M2MV would have to go down.
- The retail price would have to follow... because people that are likely buyers can't afford big down payments.
The end result is that entry level neighborhoods (especially, but not exclusively) have their values destroyed, and the banks have depreciating assets that they are chasing down... and so they just flat out won't be able to lend to anyone that can't come to the table with less that 20% or some other SIGNIFICANT down payment.
Not insignificantly would be the cost of doing this... Think about it for a minute. This isn't just for foreclosed properties, this is for every property subject to a mortgage in the entire country. We are talking about something along the lines of 70 million homes, plus how ever many commercial properties have mortgages... maybe another 5 million. 75 million properties. Currently even a bad BPO costs something like $40 and takes an agent about an hour. But, that means that even at $40, we are talking about $3billion. $3,000,000,000. And truthfully, the commercial properties are going to cost a lot more than that. If we look at the cost of an appraisal, we are looking at something more like $250. That would be $18,750,000,000...
At this point, Spencer Rascoff should be drooling... With $3billion, Zillow might be able to get within 20% of the price more than 80% of the time. Maybe they could be THE biggest vendor in that field. But, honestly, their valuations sucks. They are fun to play with, but they are not nearly accurate enough to based loan decisions and the capital requirements of our finance system on.
And that leads to the final issue...how often should these values be updated? And think about the impact of that over a 30 year mortgage. Are you willing to pay an extra $40/mo. (to be adjusted for future inflation) for future determinations of value? Or $40/qtr? Do you think that money should come out of the bank? If it comes out of the bank, you can expect that your interest rate will be going up to cover it... The final consumer WILL be the ones to pay the cost, regardless of what people in Chicago and Washington. DC say.
Bottom line...
There absolutely NEEDS to be some value assigned to assets the banks are loaning on. It makes sense. But, I don't think that the Mark-to-Market model is appropriate for real estate. It raises at least as many problems as it is designed to protect against. With stocks or other traded assets, it makes sense. Frankly, I don't know the absolute answer in this situation.
Unless otherwise noted, all content of this blog is the property of Lane Bailey, ©2012 Lane Bailey.
I'd love to hear from you...
There absolutely NEEDS to be some value assigned to assets the banks are loaning on. It makes sense. But, I don't think that the Mark-to-Market model is appropriate for real estate. It raises at least as many problems as it is designed to protect against. With stocks or other traded assets, it makes sense. Frankly, I don't know the absolute answer in this situation. Well said, indeed. Hey . . . whats the climate lie in your neck-of-the-woods? Here on Kauai we have very few sales and Sellers are still entrenched in their concept of the old prices. Its a battle of wills at this point.
Aloha
Jim
Now, I am no genius when it comes to this stuff so go easy on me... don't banks already assign a value to properties when loans are given to consumers? Isn't that what the appraisal does? And what about the county tax assessors- don't they have an assessment for the value of the land and the property? What other type of valuation are you talking about?
Again, I am not an expert by any standards in the world of the stock market- I'm just trying to understand what you are saying.
Thanks for sharing and educating a fellow agent ;)
Kind Regards, Nicole Weidauer
The Egerer & Weidauer Team, Keller Williams Realty North Seattle
Lane: My comment on mark-to-market was referring to mortgage backed securities and other debt instruments. Often these have been securitized into pools and do in fact trade on an open market. While this market is no where is liquid as say equity markets you do have sale prices which to mark against daily.. The problem is banks and other financial institutions don't want to value these assets at what they are trading for in the market because they would prove to be undercapitalized.
Their argument is these sale prices the debt is selling at are incorrect because the market is being unfairly depressed right now and it will improve later. That's like saying the stock I bought a month ago for $100 and is now trading at $50 is unfairly priced so I'm still going to value it at $100. In the case of a bank, you need to know if they have adaquate capital in hand if some action like a few big depositors pulling money forced them to sell securities into the market immediately.
You have a very good point that it's extemely hard to accurately mark-to-market an individual loan or say bank held REO.
humm...some good information thanks
James - We are off around 30% from last year... Prices are down about 10%.
Nicole - They do, but what is the value changes during the term of the loan? If the values go down in the neighborhood, the banks need to adjust their capitalization to reflect the lower underlying value.
Matt - I'm very glad that you stopped by. I understand what you are saying, and I know that MBSs are traded and there is a value to the pool... but part of the problem we are facing is that nobody trusts the values in the pool because so much is tainted from not being accurately pooled for value and rating. And so that sends us back to the underlying asset... and what is that worth. And reading a bunch of the opinions I've been seeing, the banks are supposed to have accurate values for the underlying security (the property) and not just the securitized derivative (did I say that right?)
Jacinta - Thanks for stopping by.
A++ Lane I didn't take the time to read Matt Heaton's post but I'm sure it is well written and studious. Usually the difference between Matt's comments and mine come from the fact that I sit at this very old wooden desk making decisions that affect our investors and the actual valuation of market areas all day ... every day ... day in and day out. Okay, I'm really not complaining. But Matt's comment here is dead on. And your points are very excellent and I hope it gets your readers in the question asking mode (I do maintain my stand that all of this was caused by blind sheep borrowers and had they asked the right questions in the first place we wouldn't be here ... but I digress per the norm). We (lenders and bankers) do mark REO's to market but we not only do not have time to revalue every portfolio unit to market AND, Matt is dead on, we don't want to mark those pools to market because it will expose further under capitalization. Even on properties that have been held in portfolio for 24 months and had 10% down payments we're looking at inverted cash on asset values. Hey, here's one for your readers: Credit Default Swaps.
Ken - I am also glad you dropped by. Credit Default Swaps give me a creeps... what is that $50trillion? There is NO bail-out for that market... the WORLD can't bail that market out.
My libertarian ideas are being stretched by this bail-out. I don't like it... and I don't like what I think will happen if we don't.
I missed this one back when you wrote it Lane. But here in MI we are seeing 1st hand how M2MV has distroyed some of our lower priced areas and placed those buyers in higher priced areas. Every day the prices are reduced even more thanks to M2MV.
I'm sure by now you are screaming after not 1 but 3 bail outs. lol
Ed & Cindy - Look for more bail-outs. Liking the 1990s coming back in the stock market?