H.L Mencken was right, democracy is the greatest show on earth. Yours truly has been following the financial meltdown and political process as a spectacle to behold. This is better than the West Wing.
However the most depressing thing that strikes me about this spectacle, is the intellectual shallowness of most of the leading participants. From the President down to Joe Average, the level of economic idiocy is truly astounding. What is so distressing is that the aforesaid morons, through our political process, determine the economic course of state. Is it any wonder that we are having a meltdown.
I suppose its no suprise, that one of the most 'stupid' solutions to the current crisis should come from the very orginisations that distinguished themselves so well in the regulation of the idiot bankers. Apparently the FASB has now decided that the troubled assets don't have to be marked to market. The wise public servants have determined that we are having a firesale--it's been going on for eighteen months--and the prices that the market is paying for the "troubled securities" are under what they are truly worth. According to wise at the FASB, the current accounting rules significantly understate the value of these assets and hence adversely affect the capital position of the banks. As I understand it, the FASB has implicitly said that the assets should be marked at a value that they would represent in an "orderly market".
What the hell is an orderly market?
I presume it means a market that gives me the price that I want for my asset.
Now Suppose I have a Milli Vanilli Cd which I would like to sell, and that currently, the CD is selling on the open market for 5 cents. I actually think in a few weeks people will be looking back nostalgically at the Eighties and that there will be a demand for Milli Vanilli songs, therefore true value of the CD will be about 30 dollars.
How do I price the value of my asset? What is fair market value? Clearly what the FASB allows is for the holder of an asset to determine the market value of the asset independent of what it has been trading for on the open market. This is just plain dumb and they type of stuff that frightens off intelligent capital. More opacity at a time when no one trusts each other in the banking system.
How the hell do you read a balance sheet when the value of assets is determine by what management thinks is a fair value, as opposed to what the asset is trading for in the open market? Do think there is likely to be a conflict of interest?
I suppose with march of postmodernism through the humanities, it was only a matter of time till it crossed over into the weakest of the "sciences"; economics and its handmaiden, accounting. If various and conflicting readings of the "text" are equally valid, and truth is a construct devoid of any metaphysical basis, it should be no suprise that when reading a balance sheet the numbers put down can mean anything we want them to mean.
It certainly makes investing in this kind of market a very interesting proposition.
Subscribe to:
Post Comments (Atom)
7 comments:
A Milli Vanilli CD though is a very different kind of thing from a CDO insured bond. A Milli Vanilli CD does not produce an income stream over time; a CDO insured bond does. So there really are at least two very different yet valid ways to value a CDO insured bond: as what you can get for it in a market transaction right now, on the one hand, and as what it will actually pay out to you over its lifetime until maturity, on the other.
See here.
A Milli Vanilli CD though is a very different kind of thing from a CDO insured bond.
Insured by whom? Bear Stearns, Ambac, MBIA, AIG?
So there really are at least two very different yet valid ways to value a CDO insured bond: as what you can get for it in a market transaction right now, on the one hand, and as what it will actually pay out to you over its lifetime until maturity, on the other.
What you get from the market is what you get, what you get from holding to maturity is what you might get: There is a probability of getting less than you expected. The core problem of this current market crisis is that the bankers overestimated what they thought they would get from the asset. Their "hold to maturity" projections were wrong. Yours may be to.
The central question with regard to the Paulson plan was;how much to pay for the asset?
Pay par value, and the taxpayer gets to eat the losses and the bank gets recapitalised.
Pay at less than par and more than its worth, then the taxpayer gets to eat the losses and the bank may end up undercapitalised and still fall over.
Pay less than what they are worth, the bank still ends up undercapitalised with the taxpayer being screwed again by frozen credit, though consoled by the fact that his welfare is in part paid for by the CDO's his government owns.
Finally, there is also the possibility that the taxpayer pays less than what its worth but just enough to capitalise the banks. This is an unlikely scenario as the massive leverage employed by the banks meant that their capital base was wafer thin. In fact thanks to the Basel 1 accords, part of their capital base was probably the same toxic waste--made AAA grade by the miracle of insurance--that they are now trying to flog.
This was a roundabout way of recapitalising the banks to the tune of 700 billion dollars. Lumping the risk on the taxpayer and leaving intact the management structure, executive salaries and the shareholders who knowingly took the risky investment. I suppose this is why he wanted immunity from criminal prosecution in his proposal to congress.
No, the age old principle of capitalism is that he who coughs up with the cash gets a share of the action. If the taxpayer is going to cough up, then he gets ownership of the credit transmission mechanism, tough luck shareholders, you shouldn't of been asleep at the wheel.
Should high interest rates or deflation set in, default rates will soar while property values will decline. Furthermore, with all the money being thrown around, aggregate taxes are going to have to increase, decreasing effective discretionary spending. The current market valuation of these assets may well prove to be optimistic.
I'll take my Milli Vanilli CD over your mezzanine tranche, synthetic CDO squared. The returns are likely to be greater.
Pay par value, and the taxpayer gets to eat the losses and the bank gets recapitalised.
Pay at less than par and more than its worth, then the taxpayer gets to eat the losses and the bank may end up undercapitalised and still fall over.
Pay less than what they are worth, the bank still ends up undercapitalised with ...
You seem to be admitting here that the current market price is not the same thing as the actual value of the asset. The actual value in general might be lower, and it might be higher. The market price is just a piece of information -- a very useful piece, to be sure, but it is just information about the perceived value of a thing in a particular market at a particular moment in time.
You seem to be admitting here that the current market price is not the same thing as the actual value of the asset.
That is correct. Price is what you pay, value is what you get. The two may be totally uncorrelated. Pay less than what the thing is worth and you make money, it's not rocket science.
The problem is however, that value can only be determined with certainty--that is zero risk--at maturity. Prior to maturity there is always a probability of loss and hence the ultimate value of an asset may end up at variance with the projected value made by the investor. Valuations of assets, made prior to maturity, are speculations. Though admittedly the speculations may be intelligent and reasonable.
Market price on the other hand is what the market is prepared to pay. The opinion of the investor or asset holder does not matter. Market price is a fact, projected value an opinion.
Mark to market accounting does have problems, in that good companies may be significantly undervalued by the market, with all the problems that that causes. However, accounting rules should reflect the facts of the business, not the opinions of interested partners, especially where there is a risk of conflict of interest.
The problem of mark to opinion accounting is whose opinion do we use? Richard Fuld's?
If you feel that the market has got it wrong, by all means pile in with your money. But paying above market prices, for assets that you think are worth more than the market price with other peoples money is just wrong. I'd be more prepared to accept the proposal if Hank had put a significant chunk of of his 500 million in the game. Of course he wasn't prepared to do that.
I don't know what constraints there are on what personal investments the Secretary of the Treasury can make; but there are some hedge funds getting into the game, and for all I know Paulson may be an LP in one or more of them. Of course part of the issue is that they may be good investments as long as the financial system is restored to reasonable health, and not otherwise. If that is the case, they might be a good investment for Treasury, not so much for a smaller player. In fact more generally that is another problem with viewing the current bid price in some particular market as something more than just another piece of information: a particular investment might be very valuable to investor A for a variety of reasons, and not so valuable to investor B.
Even more generally speaking, a hard-liner price theory of value is poppycock: it is just as ludicrous as the Marxist labor theory of value. A current bid price or most-recent-transaction price in a particular market is just another piece of data: often an important piece of data, but certainly nothing more profound than a piece of data.
Even more generally speaking, a hard-liner price theory of value is poppycock:
Yes it is, except in accounting. In preparing a financial statement, the role of the accountant is to present a factual statement of the financial affairs of the business. Valuations are opinions with a reasonable risk that they may be wrong. Market prices are facts. Let's stick to the facts. If the investor thinks that the market is wrong, he is free to make his own decisions.
Interesting discussion, thanks!
Post a Comment