Noteworthy:
"Nevertheless, some observers believe fair-value accounting should be retained, and that the prices of so-called toxic assets in the market are reflective of “real” value, no matter how low those prices go. They argue that home prices will fall significantly farther and that more foreclosures will occur. Therefore, they reason that market prices for toxic assets (no matter how low) reflect reality.
The problem is that all this is forecasting. Proponents of fair-value accounting believe current market prices are correct, and that anyone who wants to price them higher is “marking to myth.” In reality, these pessimists want to “mark to model.” Their models say the world will get much worse. So no matter how low the price for any security drops, they believe that drop is most likely justified.
This is where a larger and more systemic error is created. Since mark-to-market accounting reduces the capital position of our banking system, it impacts the broader economy. The accounting rules themselves create a self-fulfilling prophecy, setting off a vicious economic cycle. Capital contraction harms lending, which in turn hurts the economy, which in turn lowers the prices of assets, which then reduces capital even more — starting the whole cycle over again."
Whose idea was it to go to "mark to market" asset valuation, Barney Frank and Chris Dodd? Seriously, who was it? And, did they know what economic problems would be caused?
ReplyDelete"And, did they know what economic problems would be caused?"
ReplyDeleteDid they even CARE what economic problems would be caused?
Obviously not.
It's criminal the way they (and their Dem crony enablers) are diverting attention away from their responsibility for the carnage they caused.
Being a CPA with experience in financial services, I have a view that is in between the real world and the accounting rules. My problem with the statement is that you are required to mark your positions to what is essentially a liquidation value without any recognition that there is intrinsic value to the investment. There should be some thought given to the cash flows that you are still receiving on the investments you are not going to sell. In a great number of cases the cash flows are what you are buying anyway so you are going to hold until you are not getting those flows. I think the prior rules were much better because you could specify your intent and mark to market the positions that were intended as more short term positons.
ReplyDeleteWhen I was following the process to introduce the mark to market rules it was obvious that this was going to happen because a liquidation value does not take into account the true value of a business. How many times is a business combination actually valued at market? Almost never becuase you have to pay up for some kind of premium. These rules do not let you value the premium. What is even worse is that you cannot mark your assets up when the market comes back! You are stuck with only the bad side with no chance to return to the good side. This is truly one of the things I hate about accounting and the people in charge of the rules.
Exactly right, delow.
ReplyDeleteWhy do you think there is such resistance against changing to a more realistic scenario?
I think a lot of the academics do not want to admit they are wrong.
ReplyDeleteThey have been on a course to achieve the holy grail of fair value for the balance sheet for more than a decade. They cannot say they were not warned. If you look at the comment letters on the issue, the financial services industry was not keen on the concept at that time.
I also wanted to add that the problem is not that mark to market is a bad idea. Where it becomes a problem is when you are not able to mark your investment back up to market value once it has fallen. This happens when auditors require you to identify the asset as "impaired". Once that happens you are not able to write the asset back up once the market recovers. In the current environment we see this when some of the mortgage securities are valued in the market way below what the ultimate economic value will be. Since a company may not feel that the price will recover in less than 12 months their auditors will likely require them to permanently write down the investment. Once the market comes back, there is no recovery until the position is being paid off.
ReplyDeleteI do think this will come back to help the companies as the investments are paid off. These securities are going to start having gains at some point because maybe 10-20% of the mortgages are actually bad and the rest will be paid as normal. If the company writes the investment down below that 80% value then there will be economic recovery in the future.