As with most market turmoils, the accounting profession and, more particularly, accounting standards that deal with valuation, has been put in the spotlight again. 3 issues have been cited.
The first of these concerns “procyclicality”. Bankers say that in a downturn fair-value accounting forces them all to recognise losses at the same time, impairing their capital and triggering firesales of assets, which in turn drives prices and valuations down even more. Under traditional accounting, losses hit the books far more slowly. Some admire Spain’s system, which requires banks to make extra provision for losses in good times, so that when loans turn sour their profits and thus capital fall by less.
The second—and immediate—question is how to value illiquid (and sometimes unique) assets. A common solution is to use banks’ own models. But some investors are concerned that this gives banks’ managers too much discretion—and no wonder, because highly illiquid (or “Level 3”) assets are worryingly large relative to many banks’ shrunken market values. Such is the complexity of many such assets that it may not be possible to find a generally acceptable method. The best answer is to disclose enough to allow investors to form their own views.
The third problem is a longer-term one: the inconsistency of fair-value rules. Today the treatment of a financial asset is determined by the intention of the company. If it is to be traded actively, its market value must be used. If it is only “available for sale” it is marked to market on the balance sheet, but losses are not recognised in the income statement. If it is to be “held to maturity”, or is a traditional loan, it can be carried at cost, subject to impairment. This is a dog’s breakfast. Different banks can hold the same asset at different values.
Rather than indulge in a deadly analysis of the fascinating area of what constitutes "true and fair" value, which may actually be a cure for insomnia and, create new precedents in medical science by introducing gas-less anasthesiology, I would much rather that you read The Economist piece yourself here.
3 comments:
Do you see a new world order resulting from this financial crisis? It appears that the US is rapidly becoming a toothless tiger, financially. Some South American countries are now looking to China and Russia in forging trade pacts. Whither capitalism?
This financial crisis is not a catalyst for a "new world order". But you're right in that it will require a serious revision to certain aspects of rampant capitalistic greed. Since the
1980s the US investment banks have been creating paper instruments to trade on. These so-called financial products are derivatives i.e. derived from real instruments such as home mortgages.
These products are far removed from the real world. Many assumptions were made about these products. The current crisis exposes the dangers about making assumptions in creating derivatives. After a while things become so complex that nobody knew how far removed the assumptions were from reality.
As for trade pacts, these are not extraordinary. Trade pacts are intended to manage trade barriers such as import duties and excise taxes. Trade pacts create preferential relationships to lower cost of imports and exports of goods and services between clusters of countries. AFTA and NAFTA are good examples.
For many decades, the US GSP was the most important to many countries exporting goods to the US, which is still the world's largest consumer. In fact, because the US is the world's largest consumer countries like China and Japan may end up contributing to the US bailouts by "lending money" in the form of buying US Treasury Bills (which, for some reason, is considered very safe!!!!).
For many decades, the US GSP was the most important to many countries exporting goods to....
Isn't it analogous to a story about a successful businessman who borrowed money from 3 loan sharks for social indulgence. When the businessman couldn't service the loan, each of loan sharks became his bodyguard and force him to continue with his cash cow business and they take turn to take the daily collection. :-D!
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