, at times of stress, these premia are large and overshoot, lowering asset prices below economic value. in this situation, a marked to market balance sheet may give a misleading impression of banks ’ worth. and if these distortions are large enough, fair values could even generate insolvency. during this crisis, the precipitate rise in liquidity premia and fall in asset prices may have called into question the viability of many banks had their assets been fair - valued. consider again the banking book of uk banks on a mark to market basis. chart 7 shows the loss of value on this book, which would have peaked at over £400 billion during the early months of 2009. the total capital resources of uk banks at that time were around £280 billion. in other words, the uk banking system in aggregate would have been technically insolvent on a mark to market basis. the recent recovery in asset prices has been almost as remarkable as the preceding fall. it has meant uk banks were back in the black within a matter of months. “ liquidity and fire - sales ” the act of marking to market may itself have a bearing on asset price dynamics. this arises because of its potential effects on banks ’ behaviour. if swings in perceived solvency cause banks to sell assets, these fire - sales may themselves add to downward pressures on asset prices. under mark to market, these pressures are felt by all institutions, not just the seller. in effect, fire - sales by one firm have negative externalities for all others. and as other banks adjust their own balance sheets in response, there is a risk the downward dynamic is perpetuated. khan ( 2009 ). by acting in this way, marking to market has the potential to serve as an amplifier of stress in the financial system. 19 other things equal, it could result in sharper and more severe asset price falls than in the past, accompanied by greater institutional stress. it could exaggerate excess volatility and misalignment. marking to market may not just be a casualty of the failure of emh ; it may also be a cause. hyun shin has likened the destabilising dynamics of mark to market to the unstable oscillations of london ’ s millennium bridge at the time it opened. in finance, these adverse dynamics have a much longer historical pedigree. in their classic monetary history of the united states, friedman and schwartz assigned mark to market a key role in prop

, if they did, how many did not have a regular presence in the gilt repo market or even had no capacity to repo at all. turning up in the core secured - funding markets for the first time for years is an absolute give away of distress. all that has to change. market - maker of last resort what i have said so far could be mistaken to imply that only banking markets matter. that would be misleading. the capital markets obviously matter too. indeed, the current crisis has illustrated just what a mess can result from liquidity draining out of those markets. market liquidity is endogenous : participants thinking that it might dry up can contribute to its doing so. in the early phases of this crisis, by virtue of holding large “ trading ” books that were marked to market, banks and other traders found themselves having to make very large portfolio write downs in the face of sharp rises in liquidity premia in asset markets. as highly - levered institutions, those mark - downs depleted their net worth to the point of imperilling solvency. that caused a retrenchment in the availability of credit, helping to plunge the world economy into recession, and so impairing the value of more traditional loan books, in a vicious spiral. so it would have been better if, somehow, we could have preserved the liquidity of the markets. liquidity insurance facilities that underpin banks'funding are obviously helpful to that, as they increase the probability of bank - dealers being able to finance unwanted inventory. but some voices have argued that the authorities should act more directly to preserve market liquidity ; or, in other words, that central banks should stand ready to act as a market maker of last resort. 23 certainly, the profound changes in the structure of the financial system over recent decades should not leave us blindly attached to mid - 19 century precepts. but nor can we be blind to the challenges in embarking on acting as mmlr. in the first place, whereas lending to a bank does with certainty give that bank more liquidity, entering a market as a buyer does not automatically enhance the liquidity of that market. secondly, whereas central banks can protect themselves against the risk in secured loans by requiring more collateral if conditions deteriorate, an outright purchase is a one - off transaction ; if we pay too much given the true risk, that ’ s that. cushion, a bank should hold a core of the most reliably liquid assets