Several years ago I put a press release announcing the appointment of a new Chief Accountant at the SEC. He was a former partner of an accounting firm where I was also a partner. At first I thought it was a positive development. A high profile accountant should ensure sensible accounting policies, regulatory agency at the head of GAAP.
The first offer I saw from the new accountant advised me of this view. "I'm just a little old country boy who wants to market values," came fromthe mouth. I was not sure what he meant. In the past, when I heard the phrase: "... Little ole 'Country Boy," I automatically reached for my wallet.
I, along with all publicly traded companies, soon found out exactly what he meant. He led the strict mark to market rule for capital investments such as bonds and mortgages. This approach had a direct impact on the balance sheets of banks, insurance companies and other financial institutions. Until now, life insuranceespecially publicly stated that it was selling long-term contracts. Therefore, on balance, they had always written off the above-mentioned types of investments in value. The exemptions for insurers had here:
1. The above assets are suffering from permanent disability.
2. Separate accounts have been variable annuities and similar products, where such assets were generally normal, where stocks and other species was carried out at market value was bound.
The ChiefAccountant advocates of market-value approach with a near-fanaticism. An exception was allowed, for an insurer, with all the intention and ability to take up the obligation to maturity. However, if a company is traded or disposed of such assets prematurely, there were significant penalties. These sanctions seemed to spook the national accounting firms. Whether consideration for one of their own as the Chief Accountant of the SEC or the actual fear of him, it seemed advisable toto hold even against thinking about the liberation of the amortized cost.
In the meantime, continue to emphasize accounting for insurance companies at amortized cost too. Of the six categories of "investment grade" for these assets, and the lowest was for people with permanent or significant impairment. The latter would be valued at market value, but continued the great majority of these assets at amortized cost on the balance sheets.
Until recently there was little dispute about how thecalculating market values. Predominant activities were often available with the published market value. If not, could the present value of cash flows to be used with a prevailing discount rate, since these, at least implicitly, was the basis for tradable values.
Damage to this approach was revealed in the Enron bankruptcy. Exotic energy futures have been no published market values are available. The pattern of future cash flows, was basically unknown. Apparently, the company has its own cash --Currents and "market value" of each quarter, with net blatantly obvious approaches, but as an objective attempts to cash-flow estimate.
Redefined Mark to market and economic turbulence
Recent so-called economic turmoil really comes from the accounting distortions. For many securities have disappeared in recent trades. Many securities, even if not carried out, has been temporarily illiquid. Rather than using the present value of cash flows, a newInterpretation of the "market value", ie, liquidation or fire sale value has been uniformly followed. Obviously this interpretation of the SEC has a market value.
The result was that temporarily illiquid securities from banks and other financial institutions were immediately subjected to drastic depreciation balance. This transfer, of course, to retained earnings. Banks, brokers, investment banks, insurance companies, even giants such as AIG tottered on theVerge of bankruptcy. Ratings were also affected very negatively, as these a significant reduction in retained earnings and other measures of financial soundness. Mergers, mergers imposed by the government or public bonds ( "rescue") have the order of the day.
In the words of Holman Jenkins, a recent Wall Street Journal "Mark to Mayhem," "banks, but is subject to regulatory capital standards and therefore can be made insolvent overnight based on an accountingDepreciation. "The asset write-downs forced triggering receive much lower capital, which is exactly what happened.
Two other items with his finger on bad accounting for the recent crisis, "Mark nonsense," by Steve Forbes in Forbes, 9-15-08, and "How to Save the Financial System" by William Isaac, in a recent Wall Street Journal edition.
Some have said that the rating agencies, investors and others who deserve to know the current status of the asset portfolio. In otherWords, they deserve it, what the current "fire sale about" values of securities. One approach would be to expose these values, together with management, that these values are only temporary in nature (if not permanent damage) and do not reflect any intention or need to sell itself now.
On 30 September 2008, the SEC's current Chief Accountant 2008-234 statement. She explained that when determining market value, using discounted cash flows was acceptable, evenin the absence of a final, completed. This extraordinary statement could be a legal admission that his earlier statements were made in this field are made entirely wrong. In any case, it would have a significant positive impact on the balance sheet and retained earnings levels. Third quarter GAAP financial data have shown dramatic improvements in results, due to revised market values and institutions, while on the brink of bankruptcy could now imagine how a restoration of health.
The sad aspectthis could well be that such institutions were never wavered in the first place, but were victims of bad accounting.
Recent Developments
A few days ago, Wells Fargo Bank presented an offer for Wachovia assets was much higher than Citigroup's. The latter offer came before the above-mentioned SEC release, the restoration of the historical methods for determining the market value. It can be very interesting to see whether there is a connection between the new money and Wells Fargo a probably veryto change significantly, positive accounting.
Momentum for a government bailout of financial institutions before the start of 9-30 SEC announcement. Most unfortunately, after a failure, a revised bill was passed by Parliament 10 3 08 (for Senate passage on 10 1 08). The total cost of the bill is given as graduation from 700 billion U.S. dollars. It may be 350 billion dollars to the secretary of the Poulson for its planned purchases of "difficult" assets (at prices he obviously) sets. IF market values rocketThere is upward, according to prudent accounting, Poulson, perhaps not many will find attractively priced investments. With permanent impairments would be covered by this bill, to be sure. However, should the government strings that would come with each purchase can go to discourage such transactions. One can hope, always!
Abstract
The current "crisis" to be sure, a rise in assets permanently impaired. Defaulted loans and other distressed assetssignificantly higher than in recent years. However, the great mass of the crisis is really due to bad accounting. In other words, it is an artificially induced crisis from the regulatory requirements of the fire sale of interpretations of the "market value", rather than the rational one of the present value of future cash flows.
Financial institutions should be able to use these market values for balance sheet presentation of the performing assets. For abuse of market value and recently prevailing fireSales figures, they should be in the financial statements disclosed.
I hope, rather than a "bailout", this approach may at market value and restore confidence of investors and ensure that our economy can go from Scary setback.
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