Two Nobel laureates have entered into the valuation debate and are calling upon financial institutions to provide a more accurate portrait of their illiquid assets to investors. Robert Merton first commented on the issue in a column for the Financial Times on Aug. 18 in which he said banks that opposed mark to market accounting were simply looking to conceal depressed prices.
Myron Scholes echoed those comments in an Aug. 19 interview with Bloomberg, with both men urging banks to mark more securities to market and put any hard-to-value securities on public exchanges wherever possible.
According to Scholes and Merton, such a move would give investors better data on prices to more accurately reflect the value of an institution’s debt and equity securities.
Scholes and Merton shared the Nobel Prize for economics in 1997 for helping invent a model for pricing options. They also learned about the danger of leverage firsthand. Merton and Scholes were the creators of Long-Term Capital Management, whose collapse in 1998 was the largest-ever hedge fund failure at the time.
At one point, Long-Term Capital Management held more than $100 billion in assets. However, the firm was highly leveraged, borrowing billions to make big bets on esoteric securities. When the markets took a turn for the worse in 1998, the bets backfired and Long-Term Capital Management lost most its money. Fearing that its collapse could set off a full-scale market meltdown, the U.S. Federal Reserve stepped in to orchestrate a bailout by 14 lenders.
Ironically, there was only one naysayer among the 14 banks that agreed to the rescue: Bear Stearns.