John Gapper FT’s Business Editor writes
However, just as an exercise, imagine what it would be like if all homeowners were forced to mark to market the value of their homes, and post cash collateral in cases of negative equity.
Of course, households are not banks and do not have shareholders and bondholders, so there is probably no good reason for them to mark to market their assets. Still, it makes you think.
What is wrong with this is that it doesn’t matter if households have shareholder or not, actually they very much do have at the least stakeholders, people who are part of the household.
The key determinant of marking an asset to current prices or cost which ever is lower, is whether the asset is used as a trading asset or is it a holding asset. Businesses do not mark to market their plant & machinery, furniture or office buildings as long as they are not trading in these things. If a business buys and sells houses then they would mark-to-market if the house prices fall, else they would simply keep it at cost at which it took to acquire the inventory.
The obvious problem with Financial Assets is that their cost price especially for complex options, derivatives etc is essentially a combination of market prices and the model used for valuation. This gives unrealised gains and losses for these assets which can be huge.
The key to solving this is to go back to basics, look at the point of time when the asset was created and simply treat that as the cost of the asset, banks should not be allowed to take profits if prices move up unless they actually sell the asset, but they should have to write-down the value if the prices fall.
This will create a natural disincentive to creating complex products where the financial institutions cannot realise the gains without actually selling the asset, but would take losses if prices fall.