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October 14, 2008
Finding "fair value"
In the search for solutions to the financial mess, some politicians and pundits have latched on to the rules for "fair value" or "mark-to-market" accounting as the villain. They claim that these rules cause financial institutions to fall into a situation of undercapitalization because of low asset valuations.
Yes, I will concede that there is a danger of valuing these assets at fire sale prices.
But the old way of accounting was simply wrong. Based on amortized costs, at best it was an ostrich-head-in-the-sand approach. At worst it was just another way to cook the books. As was noted in an earlier posting, one of the reasons why banks are afraid to lend to one another is that they know the types of accounting games that came be played -- and they simply don't trust their counterparties' books.
Well, it looks like in Europe at least, the politicians have partly won. But according to the Financial Times, at least Gordon Brown is raising the voice of sanity - (Fair value accounting rules eased):
The issue has stirred up a political storm with French and Italian leaders, among others, pushing for an easing of the rules. However, Gordon Brown, UK prime minister, said in a press briefing: “Some people are looking for a get-out-of-jail-free card and an easier way of registering their financial position than is the truth.”
He warned that changing the accounting was not a quick solution. He said the world had to find “a level playing field” and not just offer “a breathing space”. “It’s just a lot of money put on one side of the accounts to make things look better.”
Brown is absolutely right. We need to find a level playing field to deal with hard to value assets -- and not just with the current troubled assets. As we move further into the I-Cubed Economy, all sorts of other intangibles assets will need to come into play. We will need transparent and reliable methods for valuing these assets.
There are other methods. As Susan Woodward, a former SEC Chief Economist, points out, Fannie Mae has accurate models for valuing mortgage assets (Rescued by Fannie Mae?):
Some argue that Fannie is discredited for this work because it, too, has losses on riskier mortgages. But Fannie's losses arose from a failure to reserve adequately for losses that were anticipated by its models. Fannie's business people overrode the risk managers when making the decision to keep reserves too low. The models were right.
We need to explore and officially adopt these models. The old head-in-the-sand approach is responsible for getting us into the mess we are in. It will not help us get out. Nor will it help us prosper in the future.
Posted by Ken Jarboe at October 14, 2008 9:45 AM
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