while there are rather more out there.First, Markit data is based on a limited sample of extant securities: 20 each for ABX and CMBX. Second, speculation involving these indices may be introducing downwardly biased distortions.
These are plausible reasons, and there is some evidence that these securities are being undervalued. It is noteworthy that some of the biggest FIs feeling the wrath of Markit are its owners, like Merrill Lynch and Citigroup. While these FIs may have reason to say that these indices are too negative, accountants of these FIs are keen on using available data to avoid charges of client favoritism. We'll see what happens...
The indices' relentless fall (see chart) has added to pressure on banks, such as Merrill Lynch and Citigroup, with big mortgage-related holdings. Citi's shares slid to a nine-year low this week on talk of a further, $18 billion write-down. Banks that mark assets far from where the indices trade incur the ire of their auditors.
The indices are undoubtedly useful, but some people think banks are putting too much emphasis on them. They capture only a narrow slice of the market: the ABX references 20 securities, for instance. And they are prone to distortion (mostly downwards) by heavy speculation. “They are not liquid enough to take the weight of short-selling heaped on them,” says one fund manager, who adds that the ABX “will probably be remembered as one of the most crowded hedge-fund trades in history.” One version of the CMBX implies losses more than 30 times greater than those suffered to date, a multiple that strikes some people as implausible. Dick Bove, a veteran bank-watcher with Punk Ziegel, recently denounced Markit's indices as “fallacious”. He expects to see write-ups as their flaws become apparent.
Intriguingly, Markit agrees with the sceptics, up to a point. The firm is working on a report that will highlight the limitations of the ABX and champion other inputs, such as new issuance and recent trades in similar securities, that can help value credit instruments, “Two years ago we had to tout [the ABX's] virtues. Now people consider it to be more relevant than it should be. They are panicking, over-reacting,” says Ben Logan, Markit's head of structured finance. He hears frequent complaints from banks on both sides of the Atlantic saying that their auditors want to see entire portfolios marked to Markit indices.
Yet the accountants want to avoid any impression that they are going soft on clients. They fear that would open them to the sort of criticism—and legal action—that engulfed them after the dotcom crash. They are already under fire for allowing eager profit-booking in mortgage securitisations. Sticking with a widely used index is safer than waving through valuations based on banks' own models. “It's cover-your-ass stuff,” says Mr Logan. He hopes that Markit's research will persuade the bean-counters to take a broader view. Some regulators also urge them to lighten up, especially in their treatment of structured products. Relying on a single data point is “lunacy”, says a senior Wall Street banker. “But these are crazy times.”
Markit's self-criticism may seem odd, but bear in mind that it is majority owned by a group of 16 banks, including such walking wounded as Citi and UBS. By and large, their internal models paint a less depressing picture than the ABX and CMBX do. If the auditors can also be persuaded that the indices are unduly pessimistic, the banks may be able to get away with smaller write-downs. If ever there was a time for banks to pick holes in one of their own products, this may be it.