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Comment by anamax | Hacker News Reader

> Traditionally, government demanded insurers have low-risk holdings to back up a sizable percent of their outstanding obligations. The regulations that handled this have been dismantled over the years.

As I pointed out in another thread, AIG's assets have not had losses and the relevant regulations have not been dismantled over the years. (In fact, AIG had to register as a bank because of new regulations.)

What happened to AIG is that the mark-to-market for those assets, which are behaving exactly as predicted, went away. (AIG's portfolios are not taking a foreclosure hit because they cherry-picked.) That took AIG's credit rating down and then the covenants kicked in, requiring AIG to pay money that it didn't have.

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FWIW, daily mark-to-market as a way of valuing long term assets was the rule before the great depression, was suspended under FDR, and reintroduced during the Bush admin (I think during the Enron reaction).

Mark-to-market is attractive, but does it necessarily make sense? Suppose that I have an apartment building that is throwing off enough cash to meet my obligations. Is it worth nothing on a day when no one offers to buy it? Is it worth nothing on a day when no one offers to buy "comparables"?

Mark-to-market applies only where the value of an asset is at issue. If, for instance, you want your insurance company to have a minimum value for its assets, to insure that they can pay out in case they need to, then you don't care what that asset is earning. All you care about is the value of that asset when sold, so that the insurance company can use that money to pay off its obligations to you.

Suppose I offered you $10,000 worth of stock in AIG as collateral for a $10,000 loan. When the value of that collateral goes down, it's fair for you to call the loan, even if AIG is still making money and distributing dividends.

These is the way that a bank treats its own customers who put up property as collateral, but when banks themselves are putting up collateral, they want to operate under different rules.

> Mark-to-market applies only where the value of an asset is at issue.

The value of bank and insurance company assets are always an issue.

> Suppose I offered you $10,000 worth of stock in AIG as collateral for a $10,000 loan.

That's a different situation because (as I understand it), the "collateral" was performing loan portfolios.

I agree that the market price for those porfolios is relevant but does it really make sense to immediately declare an institution insolvent and all that implies when buyers take a holiday?

There was some stock involved in many of these cases, but it was the stock of Fannie Mae and Freddie Mac. The US govt gave tax and other preferences to regulated institutions that held Fannie and Freddie stock as assets. This pretty much guaranteed that a lot of them would take a huge hit when Fannie and Freddie went down.

The danger of "Mark-to-market" is that one market decline can set off another which sets off another and pretty-soon you have a world-wide-financial collapse (oh, perhaps I'm exagerating...).

The individuals who create contracts which involve mark-to-market values might not care about these contract's potential to set off systemic collapse. The state or the regulators or "the people" jolly-well ought to care.

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