The root of the credit crisis?

This one sat in the draft bin for quite a while. Interesting, though, so I'll go ahead and post it, several weeks later...

An article on Newsweek claims to explain where the current credit crisis came from, and it's a fascinating story.

The article goes into some fairly arcane accounting and financial market mumbo-jumbo, but I think the upshot is this: Investment vehicles (mutual funds, hedge funds, asset-backed securities which can include sub-prime mortgage-backed securities, etc) state their value by a rule called "mark to market". In other words, the proprietors of such vehicles determine the value of their assets by comparing them to the market values of similar assets. These valuations are, of course, subject to audits and can't be total figments of imagination.

However, exotic securities (including the aforementioned sub-prime mortgage-backed securities) are so new and traded by such a small niche of the marketplace, no one really knows what the market is, especially in times of panic. So, these securities are often valued by a method called "mark to model" - the market is small and there isn't much history to go by, so the Wall Street boys and girls use predictive models to divine a value.

Both methods, "mark to market" and "mark to model" are subject to a great deal of psychology. Like almost all markets, securities have value because enough people THINK they have value. Once the psychology gets shaken, the whole thing can crumble.

A number of people who know a hell of a lot more about this subject than I do, including former Presidential candidate Steve Forbes, have called for an end, or at least a suspension, of "mark to market", contending that times of panic render this valuation method worse than useless.

I don't know what to think of all this. It certainly makes sense on the surface, but my grasp of the investment market is hazy at best. I think I understand the role human psychology plays in the whole thing, and that's what scares me the most...