Tuesday, July 21, 2009

Tom Selling on Derivatives

"The FASB's own Investors Technical Advisory Committee (ITAC) wrote a strongly-worded letter to the Financial Accounting Foundation decrying that current events have eroded the FASB's independence. ... That's because the FASB has never acted in an indepdent manner. When pressed, it folds like a cheap suit. ... The butcher's knife view of derivatives is that they are primarily used a 'hedging' instruments; and the opportunity to hedge risks promotes investment. ... First, they have been used to transfer risks to to others who may not have understood the risks, due to lack of sophistication and/or transparency. Second, and to my view the more fundamental problem, is the way that managers 'game' the derivatives accounting rules to accomplish personal objectives at the expense of shareholders. ... My client, let's call it OilCo, produced and sold oil and gas. ... But, shortly after oil prices reached a level that had not been seen for a number of years, management made the decision to invest in crude oil forward contracts. ... By entering into a forward sale of its production at a fixed price, was management of OilCo hedging against future adverse changes in oil prices, or were they speculating that oil prices would decline? ... And what the heck is a 'derivative' anyway? ... Throw away FASB Statement No. 133's hedge accounting provisions and require that all derivatives be fair valued", Tom Selling at the Accounting Onion, 29 June 2009, link: http://accountingonion.typepad.com/theaccountingonion/2009/06/regulate-derivatives-start-with-better-accounting.html.

Yes TS! I have similar experiences to yours with OilCo with two silver mining companies. SFAS 133 is a pile of economic rubbish. The FASB has been "epicycling" away with this 1,060-page monstrosity for years. Kill it. Jim Leisenring also suggested fair valuing derivatives, my 12 June 2009 post: http://skepticaltexascpa.blogspot.com/2009/06/ia-goes-to-meetin.html. Derivatives can't promote investment, they can only push around risk. They are a zero-sum game. For every "hedger" there is a "speculator". The distinction is metaphysical nonsense.

1 comment:

Anonymous said...

I wonder if a mathematician has added up all losses and gains known for CDS...

AIG alone would cover gains of many other firms.

Oh... you mean accounting encourages certain types of behavior? What an incredible concept.