An avid reader wonders after my post on the dangers of being ringside to hear the death rattle of desperate financial institutions or other issuers/holders on the wrong side of credit crunches and collapsing asset prices. I pointed out that the nature of "Mark to Market" accounting incentivized market actors to avoid transactions that might cause markdowns, or otherwise attempt to "manipulate" markets to minimize their exposure to derivatives. I commented:
Are we surprised when people point fingers at Bear and suggest, for instance, that they are buying up the underlying assets and loosening credit terms on the debtors to avoid a default, a mark to market problem and, to boot, to avoid paying, for instance, on credit default swaps- for which their liability is much greater than taking a complete loss on the debt itself would be?
There are any number of instances where firms that stand to lose from "Mark to Market" or other provisions in instruments that might be triggered by chaotic markets, employ any number of tricks to avoid a repricing, or the pain of market action. CDOs and such are not nearly the beginning or end of such tactics.
"Loosening credit terms on the debtors," isn't exactly an apt description of the kinds of things that would be particularly effective in dealing with e.g., credit default swap liabilities. However, buying up defaulted asset backed securities at par to artificially prop up CDO valuations (mark to market, remember), inject cash into the flagging CDO structure and avoid triggering credit default swap liabilities on the instrument, is. The key distinction that makes it wildly worth it to attempt such a thing if you are on the wrong side of a credit default swap is the fact that 10:1 to 100:1 leverage is often being applied such that the derivative liabilities floating above the assets may vastly outweigh the value of the underlying instruments. Pretty cheap to just stick your hand in the black box of "mark to market" and prevent a write-down that way, nay?
Then there are the other little tricks we are starting to see. For instance, resort to "mark to model" (or "mark to myth") accounting, and turning a blind eye to the double digit asset price declines that should probably have been in the model six months ago. Desperately trying to hang on to foreclosed assets to avoid a dump on the market that will push assets down even further. And so on, and so on....