Friday, March 7, 2008
Show Us How Smart You Are
"The massive write-downs that financial firms are posting have begun to spur a backlash among some investors and executives who are blaming accounting rules for exaggerating the losses and are seeking new, more foregiving ways to value investments. ... Also rattling investors was a report by UBS that said losses among financial institutions could top $600 billion as the turmoil in global credit markets continues to unfold. No one, including the chairman of the [Fed], Ben Bernanke, knows with certainty what would be a better approach than using market prices for valuing holdings. ... Despite the grim developments, many investors actually doubt that firms like AIG will suffer the full force of the losses they are now booking. Instead, these investors argue that the market has overreacted and will recover once the current panic subsides. ... AIG's argument ... [is] a sore point because companies feel they are being forced to take big financial hits on holdings they have no intention of actually selling at current prices. The firms argue they are strong enough to simply keep the holdings in their portfolios until the crisis passes. ... The use of pricing models that don't pay heed to market values was discredited after Enron Corp. used them to book phantom profits earlier this decade. Enron, for example, would book a profit on a contract to buy or sell energy years in the future based on it's own expectations of how much the contract would be worth over time. ... Robert Hertz, chairman of the [FASB] ... 'But you tell me what a better answer is,' he said. 'Is just pretending that things aren't decreasing in value a better answer? Should you just let everybody say they think it's going to recover'?" my emphasis, David Reilly (DR) at the WSJ, 1 March 2008.
DR should have been more critical of those who favor "mark to model" accounting. Are the bank executives who claim these portfolios will recover buying their employers' stock in the market? If say, Citigroup gives me a margin loan, will it say, "sure, no problem. We won't sell you out when under maintenance margin. You told us your stocks will recover". I don't think so. The idea of a return to Enron accounting is absurd. I love listening to "investors" arguments. I have one: if you believe AIG's writedowns excessive, you have an opportunity, buy AIG on margin and in two or three years we'll see how smart you were. Otherwise, shut up. See my 10 December 2007 post mentioning Jack Hershliefer.