Bliss for those who can ignore mark to market Thursday, March 13, 2008
Warren Buffett recently warned his investors that, under mark-to-market rules, the funds he runs may encounter volatile earnings on trades that ultimately are safe, since they intend to hold the investments until maturity rather than trade them.
Presently, anyone capable of making long term investments and ignoring current price volatility can find some attractive opportunities. For instance, the imploding Carlyle Capital's portfolio consisted exclusively of $21.7 billion of triple-AAA mortgage backed securities issued by Fannie Mae and Freddie Mac. They are considered to have the implied guarantee of the U.S. government and pay par at maturity. However, because Carlyle Capital finds itself unable to meet margin calls from lenders, the fund is being liquidated and assets sold, with these assets likely to realise much less than par.
Few banks or funds want to buy these assets in the current market as they can't be easily recycled as collateral, except at punitive haircut rates. Hence prices have slumped and concerns about price volatility is discouraging any buying by those who have to report short-term earnings that include mark-to-market adjustments.
Mark-to-market has the key advantage of not allowing firms to hide worthless assets using historic costs, as was the case in the 1990s, and illustrates the approximately realisable value of the investments.
However, provided you believe that these assets will redeem at par, which is likely thanks to an implicit US Federal Guarantee, then buying these assets at a material discount to par locks in a profit, albeit the cashflow is some years hence. Should you need to realise the cash early, you may take a hit, and likewise you may miss out on other more profitable opportunities by trading short term volatility by putting your cash into a "sit and wait" asset.
Setting aside Keynes' famous morbid but accurate comment that in the long run we're all dead, these are opportune times for anyone presently sitting on cash who can afford to take a long term position.
- At 1:53 PM, Hawkeye said...
The other side of this coin is that Mr. Buffett is actually suggesting that the reason he doesn't like derivatives is because they force him to mark to market and he has to find the cash-flow to cover this. In the markets where mark to market is not forces he can hold instruments that are seriously below the price he bought them at, but because there is no mark to market he does not have to find the cashflow. Nice one! As you say with the implicit Fed guarantee this is all well and good, but what happens if those discount purchases continue to deepen and the implicit guarantee disappears (under a new president say)?