Aug. 19 (Bloomberg) -- Myron Scholes and Robert Merton shared the 1997 Nobel price for economics, and they are now united in calling for banks to give more accurate valuations on their illiquid assets.

Financial institutions should use mark-to-market accounting or list the hard-to-value securities on public exchanges whenever possible, Scholes said in a Bloomberg Radio interview yesterday. Scholes, winner of the Nobel with Merton for helping invent a model for pricing options, said investors need better data on prices to accurately value the debt and equity securities of banks.

“I’d like to see us encourage many more securities held on the books of the banks be migrated to exchanges if possible,” he said. Doing so would “allow for market discovery and market pricing as much as possible,” Scholes added.

Banks that oppose new accounting standards on asset values want to conceal depressed prices, Merton wrote in the Financial Times yesterday. He composed the column with Robert Kaplan, a professor at the Harvard Business School along with Merton, and Scott Richard, a professor at the University of Pennsylvania’s Wharton School.

“This is not the way forward,” they wrote. “While regulators and legislators are keen to find simple solutions to complex problems, allowing financial institutions to ignore market transactions is a bad idea.”

‘Blow Up or Burn’

The Financial Accounting Standards Board said in July that it will consider expanding fair-value rules to loans, a step that might accelerate banks’ recognition of losses and trigger lower earnings and book values. Accounting rules now give managers some discretion in recognizing loan losses. Applying fair value to loans would require earlier recognition of losses.

Banks would benefit if some of their debt automatically converted to equity during a crisis, reducing the need to unload assets in frozen markets, Scholes said yesterday.

“That would mean the price to the banks and other financial institutions would increase accordingly, and the necessity of bailouts would be reduced and the necessity to sell assets at times of shock would also be reduced,” he said. “We have to think about market mechanisms that actually reduce the costs associated with adjusting capital structures.”

Frozen Markets

Regulators need to “blow up or burn” the private over- the-counter derivative markets to help solve the financial crisis, Scholes said on March 6. Because markets had frozen, investors weren’t getting timely prices to inform their decisions, he said then, speaking at New York University’s Stern School of Business.

Scholes and Merton, together with the late Fischer Black, developed the Black-Scholes model of pricing options, or contracts that give the buyer the right to purchase a security or commodity at a later date for a specified price. Black died in 1995.

Platinum Grove Asset Management LP, the Rye Brook, New York-based hedge fund where Scholes is chairman, was forced to freeze investor withdrawals in November after a surge in redemptions. He was a partner in Long-Term Capital Management LP, whose $4 billion loss in 1998 set off a near panic in financial markets and prompted the Federal Reserve to orchestrate a bailout by 14 lenders.

To contact the reporter on this story: Jeff Kearns in New York at jkearns3@bloomberg.net.

Last Updated: August 19, 2009 08:51 EDT