As If Accounting

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3 Responses

  1. A.J. Sutter says:

    Thanks for emphasizing this issue. BTW, what’s the impact of the new accounting rules on the “stress tests” for financial institutions? Will “as if” also equal “stress relief”?

  2. Frank says:

    A very valuable perspective. I am afraid that Simon Johnson is right about this trend:

    “Excessive inflation is a typical outcome in oligarchic situations when a weak (or pliant) government is unable to force the most powerful to take their losses – high inflation is, in many ways, an inefficient and regressive tax but it’s also often a transfer from poor to rich.”


    If the buying power of my 401K account and savings account is the price it could sell for now, whereas the buying power of the banks is forever propped up by these rule changes, they have much more buying power relative to me than they would without the propping up.

  3. ohwilleke says:

    Is this so new? Most definitions of fair market value, for example, in tax law, say something along the lines of “the price that a willing buyer would pay a willing seller, under no compulsion or undue influence.”

    One could, for example, expressly tie financial accounting value to the stock market valuation of the entity valued, but that would defeat the purpose of having financial accounting statements add information to the equation, rather than simply reflecting what is already known by the trading public. Bootstrapping asset value from stock market value is part of what created the toxic asset problem in the first place, because in practice, many collateralized debt obligations were valued based upon the price at which credit default swaps in those securities were trading, rather than from the fundamentals involved in the underlying asset.

    One also suspects that one could back an undistressed price under this definition out of a current foreclosure sale/short sale/distressed sale value with some sort of “distressed sale discount” valuation comparable to the cottage industry of assigning minority interest and lack of marketability discounts to assets. If some appraiser’s data set shows that foreclosed properties typically sell for 80% of FMV or $30,000 less than FMV or whatever, one ought to still be able to use foreclosure sales to reasonably estimate undistressed values, without bootstrapping.

    In the end, the purpose of financial accounting is to facilitate good decision making in ownership and financing transactions. Valuing mark to market assets based upon undistressed values, which can in turn be compared to current distressed values (thanks to the wonders of accounting statement footnoting, the real genius of the FASB system), with an undistressed asset valuation should, therefore, help decision makers determine how material the difference between an enterprise’s value as a going concern, and an enterprise’s value in a distressed asset sale — the key consideration for any entity considering steps like an FDIC take over, a bailout, or a Chapter 7 or 11 bankruptcy.

    Certainly, the job isn’t easy. It is even more difficult in the case of a complex asset like a CDO or a CDS. But, this approach should be more stable and less subject to manipulation than a price based upon a thinly traded or exceptional distressed sale. Reliance on either of those measures as a matter of FASB rule would be almost an invitation to market manipulation.