Image by ashley rose, via FlickrMark To Market
I want to tell you about Barry @ TheBigPicture. I’ve been reading his stuff for awhile now, and I’ve found him to be an enormous resource. He publishes several posts a day on Finance and Economics, always providing links to sources and more references. The information he provides is genuine, the perspective very real.
I’ll be borrowing the first few paragraphs here from his post, Understanding the Significance of Mark-to-Market Accounting. I recommend his original post even over this one, for the complete article by Barry as well as the legion of comments. Much of it is fascinating reading.
But, if you want to finish up here first, I’ll understand. So read on, from TheBigPicture…
Understand why this is even an issue: Many banks, brokers, and funds chose to invest in certain “financial products” that were difficult to value and were at times thinly traded. If you are looking for the underlying cause of why some arcane accounting rule is an issue, this is it.
In my office, we don’t buy our clients beanie babies or Star Wars collectibles or 1964 Ferrari 275GTBs. We purchase stocks and ETFs and bonds and preferreds for them (some clients also own options and commodities). Why? Because we believe — and our clients have insisted upon — the need for instant liquidity. Nothing we have purchased cannot be liquidated on a moments notice. We know what the fair value of these holdings are second by second.
While we may have been tempted by potential greater returns that some of these other products offered, we simply could not justify the risk of owning hard to value, thinly traded, hard to sell items. And, we never had to rely on the models of the individuals who created and sold us these products in the first place, to determine an actual price. If ever a product was rife with self-interested conflicts of interest, this one is it.
Now that the garbage is on the books, no one wants to admit the original error of purchasing this class of assets. Its not just that the trade has gone bad, its the original buying decision was so flawed even if the trades were not such giant losers.
Recent actions of corporate titans in the financial sector are essentially an admission that their business model was deeply flawed. No one would invest any capital for a ROI of 50 bps per year. They of course knew this — so they leveraged up that 50 bps 35X or so, creating the false appearance of more attractive returns. This higher risk, potentially higher return paper was part of that misleading process.
Suspending FASB 157 amounts to little more than an attempt to hide this broken business model from investors, regulators and the public. Its not just getting through the next few quarters that matters; Rather, its allowing the market place to appropriately reallocate this capital to where it will serve its investors best.
If FASB 157 is suspended, I would advise our clients and the investing public that owning any financials that failed to disclose their holdings accurately were no longer investments — they were pure speculations, with more in common to spinning a roulette wheel than owning Berkshire Hathaway (BRK) or Apple (AAPL) or Google (GOOG). Indeed, I know of no faster way to end up on the DO NOT OWN list than to hide from your shareholders what is on your books.
If investors cannot trust the valuations of what is on a firms books, they simply cannot invest in these firms PERIOD.
There are other alternatives for the institutions that now must deal with this discounted, thinly traded hard to value junk paper. They can sell it for whatever price a the market will bear, they can spin it off into a separate holding company, they can write it down to zero and reap the rewards of mark ups in future quarters.
But suspending the proper accounting of this paper is the refuge of cowards. It reflects a refusal to admit the original error, it hides the mistake, and it misleads shareholders. I find it to be totally unacceptable solution to the current crisis.
Regular readers here @ Wordout know that I like to publish the source documents whenever I can, or at least provide a link so you can see for yourself. Below are selected, relevant sections from the FASB 157 Summary.
Summary of Statement No. 157
Fair Value Measurements
This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements, the Board having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this Statement does not require any new fair value measurements. However, for some entities, the application of this Statement will change current practice.
Reason for Issuing This Statement
Prior to this Statement, there were different definitions of fair value and limited guidance for applying those definitions in GAAP. Moreover, that guidance was dispersed among the many accounting pronouncements that require fair value measurements. Differences in that guidance created inconsistencies that added to the complexity in applying GAAP. In developing this Statement, the Board considered the need for increased consistency and comparability in fair value measurements and for expanded disclosures about fair value measurements.
Differences between This Statement and Current Practice
The changes to current practice resulting from the application of this Statement relate to the definition of fair value, the methods used to measure fair value, and the expanded disclosures about fair value measurements.
The definition of fair value retains the exchange price notion in earlier definitions of fair value. This Statement clarifies that the exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability in the market in which the reporting entity would transact for the asset or liability, that is, the principal or most advantageous market for the asset or liability. The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the asset or owes the liability. Therefore, the definition focuses on the price that would be received to sell the asset or paid to transfer the liability (an exit price), not the price that would be paid to acquire the asset or received to assume the liability (an entry price)…
In other words, Mark-To-Market means that the value is determined by how much you can get if you’re selling it to someone Other Than Yourself. What these guys want to do is value the assets according to what they want to sell them for, instead of what someone else is willing to pay for them.
I am Jon, and if that’s the way it works, my net worth just shot through the roof.
And left a huge gaping hole.