cote - Nope not suggesting Banks should mark to market against a market failure - just as I assume you're not suggesting mark to market actually works in the event of a market failure. What I thought I said was that the combined practices of mark to market,close-out netting etc and the way in which risk is weighted and capital reserves allocated all starts to make a mockery of the entire point of capital adequacy.
I'm afraid I'm with Warren Buffet on this - back in 2002 he said:
"I view derivatives as time bombs, both for the parties that deal in them and the economic system. Basically these instruments call for money to change hands at some future date, with the amount to be determined by one or more reference items, such as interest rates, stock prices, or currency values. For example, if you are either long or short an S&P 500 futures contract, you are a party to a very simple derivatives transaction, with your gain or loss derived from movements in the index. Derivatives contracts are of varying duration, running sometimes to 20 or more years, and their value is often tied to several variables.
Unless derivatives contracts are collateralized or guaranteed, their ultimate value also depends on the creditworthiness of the counter-parties to them. But before a contract is settled, the counter-parties record profits and losses ? often huge in amount ? in their current earnings statements without so much as a penny changing hands. Reported earnings on derivatives are often wildly overstated. That?s because today?s earnings are in a significant way based on estimates whose inaccuracy may not be exposed for many years.
The errors usually reflect the human tendency to take an optimistic view of one?s commitments. But the parties to derivatives also have enormous incentives to cheat in accounting for them. Those who trade derivatives are usually paid, in whole or part, on ?earnings? calculated by mark-to-market accounting. But often there is no real market, and ?mark-to-model? is utilized. This substitution can bring on large-scale mischief. As a general rule, contracts involving multiple reference items and distant settlement dates increase the opportunities for counter-parties to use fanciful assumptions. The two parties to the contract might well use differing models allowing both to show substantial profits for many years. In extreme cases, mark-to-model degenerates into what I would call mark-to-myth.
I can assure you that the marking errors in the derivatives business have not been symmetrical. Almost invariably, they have favored either the trader who was eyeing a multi-million dollar bonus or the CEO who wanted to report impressive ?earnings? (or both). The bonuses were paid, and the CEO profited from his options. Only much later did shareholders learn that the reported earnings were a sham."
And the relevance to this thread is that while I think Greece screwed itself over in some respects (the generous pensions, tax evasion, lying to get into Euro etc), the root cause of the financial crisis comes back to the banking system so instead of enjoying the snide glow of schadenfreude, we have to consider the rest of Europe (and surely the world) as soon to follow. We cannot continue to chase "market dislocation" from bank to bank and then country to country. At some point we have to admit the "market dislocation" IS the market and not something we can now fix up to its former money spinning glory. Too big to fail can also mean too big to save and the more institutions we decide are too big to fail and the more national governments have to conjure up money (quantitative easing) to try and stop the gap the more we are all deluding ourselves, so how far from Greece are we? If London's the financial centre of the world we may stay insulated for a little while longer but as the saying goes the bigger they are, the harder they fall. And the very foundations of London's recent financial successes (1980s onwards) are firmly rooted in derivatives.