Phorgy Phynance

Fair value accounting

with 6 comments

I’m suffering a bit from information overload after just getting back from a too-short visit to HK. In response rrp dude’s comment on SFAS 140, I mentioned that some of my old colleagues talked quite a bit about the impending introduction of “fair value accounting”. I won’t pretend to have read it yet (drowning!), but thought I’d point out another interesting article:

Accountants are failing investors with “fair value” accounting

Too much information! Hopefully you’re able to keep up better than I am 😮

[Edit: Continuing after having read the article.]

Yikes! That is some wild stuff. My friends and colleagues were certainly concerned about the impending “fair value accounting”, but I don’t think they’ve raised their voices loudly enough. This is some serious stuff coming down the pipeline. I was at the WBS 2nd Fixed-Income Conference in Amsterdam last September and the CDO pricing model sessions were always the mostly lively (and entertaining). Some of the top minds in mathematical finance arguing about the best approach. From where I sat, they all sucked. How on earth is fair value accounting going to work with complex structured finance products like CDOs???


Written by Eric

August 6, 2007 at 8:54 pm

6 Responses

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  1. Phorgz, I am going to pollute your blog endlessly. I am no fan of accountant’s but I don’t agree with the guy you linked to. His characterization is an oversimplification of the set of facts.

    1) RE: Fund managers earning promote on phantom returns. There’s nothing about GAAP that requires fund investors to pay money on GAAP income. In fact, having gone through the OMs of several funds, promote (or carried interest) is generally paid on a cash basis, at least in the dozen or so I have looked at, not on a GAAP income basis. In fact, the fund I work for is done totally on a cash basis. Otherwise you can play games with accounting.

    2) No Bids: It’s true, you get a market that has no bid whatever, seriously, you can’t buy or sell. It’s not that the assets are completely worthless, it’s that the buying community either lacks the liquidity or the inclination to transact. Markets may be long run efficient, but they can get completely fucked in the short to medium term. For example, a few deals that have priced in my space have gone as far as to tell a buyer to name their spread and they just got rejected flat out. Now there is no way that the PV of all the CFs are zero, but there’s no market either. If you think that means Zero, then imagine how wrong you’ll be when you get the first monthly bond payment.

    3) ACA ignoring TABX: TABX liquidity is extremely impaired right now. And it’s an index product with no real track record (I believe it launched in early Feb 2007). I wouldn’t propose that it be ignored all together as a pricing data point, but I’d hesitate to use it with 100% weighting.

    I don’t think his argument has no merit, I agree that accounting rules are inconsistent and confusing. However it’s not as though everything is being made up as one goes along.


    August 6, 2007 at 10:21 pm

  2. Ha ! I didn’t read the other comments but it looks like your blog attracted a couple of credit people. Seeing RRP here is a good sign.

    To answer your question: “How on earth is fair value accounting going to work with complex structured finance products like CDOs???”

    Like in any other complex structured derivative: mark against your model and take big enough reserves. Don’t think that CDOs are the only mess out there (look at the thread about CMS options on NP for example).


    August 7, 2007 at 4:00 am

  3. Also on the TABX front, remember that many dealers got crossed by points when it first opened. Not the indication of market efficiency to be honest. I mean would I really mark myself to an index where quoting banks were getting taken for a ride and think that I had the right mark?


    August 7, 2007 at 6:23 am

  4. And Cheng, nice to see you here too.


    August 7, 2007 at 6:24 am

  5. […] Published August 9th, 2007 Fair Value Accounting , BNP Paribas On Monday, I commented on an article from Wellington Financial on fair value accounting. This morning they’ve […]

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