The Current Challenges of Marking-to-Market

For an excellent article on the problem of marking-to-market complex (and not so complex) securities in the current market see this WSJ article (subscription) from October 12. It provides some great insight into the massive change in write downs at Merrill Lynch, which I discussed in this post.

The article also reveals that

Some financial firms have sought in recent weeks to avoid write-downs by selling mortgage positions to hedge funds, with an agreement that allows the hedge fund to sell them back after a set period. A hedge-fund trader says his firm recently bought $1 billion of risky subprime mortgage loans from Bear Stearns with a one-year pact, known as a “mandatory auction call,” under which Bear agrees to participate in an auction for the loans that will provide the hedge fund with a minimum rate of return, according to a person familiar with the situation. “They didn’t want the mortgages on their books,” the hedge-fund manager says.

Such financial arrangements typically are considered proper if there’s an economic purpose to the trade and if risk is taken on by both parties. Legal problems could arise if such trades are part of an attempt to conceal a company’s financial picture, regulators say.

After the off-balance sheet scandals of recent years, it’s hard to believe that this type of trade has returned so soon.

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