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What's More Important than Fair Value? Plenty

Global financial experts are more keen on reining in securitization than stamping out fair value.

Marie Leone, | US
January 20, 2009

Product and Process

Many times the world views the pricing or price discover of a product as a rational process and forgets that it is a volative event. Although Fair Value does not attempt to view add volatilit to anyones books so to speak. An unfortunate after affect is that it adds a factor to the price discovery process. I would argue the CDS market was not underregulated, but was more funcitonally unware the volatility that an accounting standard would place on the securities the CDS were attempting to technically insure against. Any Accounting Standard that across the board shifts the dimenstions of a companies product in this case subprimce morts needs to go through the vetting process of how it interacts with control process IE Risk Management. Risk Managers may enter a new era of viewing accounting rules as well as the market dynamics of the products they are designed to control. Viewing a few times this argument betweeh accountants and risk managers first hand. These events will probably continue until you get the accountants rationally in the RM process upfront.

Posted by Niraj Kapadia | January 26, 2009 04:37 am

Assessing risk in the subprime mortgage market

In a New York Times article dated September 30, 1999 titled "Fannie Mae Eases Credit to Aid Mortgage Lending", the author stated, "In moving, even tentatively, into this new area of lending, Fannie Mae is taking on signficantly more risk, which may not pose any difficulties during flush economic times. But the government subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that the of the savings and loan industry in the 1980's. As I recall the S&L rescue was not in insignificant event. Mr. Nkuhluk makes the following observation in the article, "If a CDS seller understood the high risk that a rapidly sinking market put on the swap, it would have been priced into the instrument. But CDSs were not priced taking into account a risk like the blow-up of the subprime mortgage market. An unusual event like the subprime crisis rendered market information useless, says Nkuhluk." I know this may seem like a naive question but how were all the CDS sellers ignorant of the magnitude of such risks? I would submit that the subprime crisis was not an "unusual event" and was a predictable outcome of risking lending practices. Perhaps someone smarter than me can explain how aggregating all this subprime debt into these instruments decreased the risk. It would seem from casual observation that other than some geographical diversification, risk was in fact increased by definition due to an adverse selection process.

Posted by Mark Rowe | January 23, 2009 04:49 pm

Bite the Bullet

Fair market value should not be used as the excuse for not biting the bullet, just because the pointed end faces in! Everyone knows that the (real) value of anything is set by what price the market is willing to buy at, not what you believe it is worth. Decisions were made for what ever reason (good or bad) and now the piper needs to be paid.

Posted by Jake Smith | January 22, 2009 08:51 am

Wrong: It Was Fair Value that Made the Ruin!

When a parts-maker buys a coil of steel, traditional accounting keeps the steel on the books at its purchase price without regard for the fluctuating spot market. If the company timed its purchase well or poorly, the results appear in its P&L when the product is sold. Fair enough. The same should be true for financial inventories. Forcing the steel fabricator to constantly revalue its stocks would be just a migraine squared. In the case of financial institutions with capital requirements set in Basel, "fair value" is a formula for wholesale dumping into any down market and, as we have seen, world-wide financial calamity. Naturally, the regulators responsible will not admit their responsibility, but rather argue for more regulation - even of the type that caused this collapse. Greed is blamed, but that is just another way of saying "maximizing shareholder value". The regulators truck with neither. Their own greed is for power. It is rarely constructive. As we have seen before in the S&L crisis and the Great Depression, it is license to destroy.

Posted by George Brown | January 21, 2009 10:52 am

Process and Project Accounting

What also is needed is process and project accounting. We have to get away from reporting assets, liabilities, income and cash flows since these are merely products of underlying states of nature such as processes and projects. An integrated approach is needed rather than the products that are really only potentials since the past does not predict the future.

Posted by David Newman | January 20, 2009 06:38 pm

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