12 year lows

The markets are at a 12 year low today and CNBC.com had a great article about the difference a decade makes. I don't have the link but you should search for it if you have the time. It highlights the intra-year highs and lows for the indexes as well as what a barrel of crude and gas cost. Very interesting.

There is a rumor going around that mark-to-market accounting may be shelved for a while on March 12th. This would be great for the markets including all the financial stocks. Mark-to-market accounting is when an entity marks the assets on their balance sheet to the market and not what they paid for it. 

For instance; you own a house that you bought for $100,000. You have a renter who pays $500 a month and is not going anywhere. In your mind and on your balance sheet, nothing is wrong and you can pay the note on your house. Across the street there are 4 houses that were bought for $100,000 also but don't have any renters. The 4 owners are behind in their payments and have to sell their houses at a fire sale. They sell their houses for $50,000 for a loss. In this example, you have to mark your house at $50,000 on your balance sheet even though you don't have/want to sell the house for 10 years and you can pay your note.

So now your net income just took a $50,000*(1-tax rate) hit and you have lost $50,000 of equity on your balance sheet. Again not a big deal if the bank doesn't care. In reality, you haven't lost anything. You still have that renter paying $500 and you can still pay the note. Why is this such a big deal in the market now then? Because companies have ratios to meet called covenants on their loans. As a quick example, lets say you have to maintain a capital ratio of 30%. So for every $7 you borrow you need $3 in cash. 

So you have a $100,000 house which is financed with $60,000 equity and $40,000 debt. Your ratio is a healthy 133%. For every $2 you borrowed you paid $3 in cash. Plus you have that renter. The bank likes you because you are well capitalized, but the 30% covenant says that if you ever go below this level, you have to pay it all back immediately. There is absolutely nothing wrong with your house or your renter but now because the 4 idiots across the street sold their identical houses for $50,000, you have to mark your house down to $50,000.

Now you have a

• $50,000 House
  
• $10,000 equity ($50,000 Hit)
  
• $40,000 Debt
  
• Ratio of 25%
  
• Whoops!!!!
  

The bank calls and demands all of the debt repaid immediately even though nothing is wrong with you. This is what's happening in the markets and its destroying companies. Suspending mark-to-market will help the market in the short term so companies can raise more capital.