Comments on: Pandora and the Fair Value Accounting Rules http://alephblog.com/2008/01/11/pandora-and-the-fair-value-accounting-rules/ Helping Institutions and Ordinary People Invest Better by Focusing on Risk Control Tue, 16 Mar 2010 21:21:52 -0400 http://wordpress.org/?v=2.8.4 hourly 1 By: Estragon http://alephblog.com/2008/01/11/pandora-and-the-fair-value-accounting-rules/comment-page-1/#comment-16497 Estragon Mon, 14 Jan 2008 19:14:21 +0000 http://alephblog.com/2008/01/11/pandora-and-the-fair-value-accounting-rules/#comment-16497 Returning to your simple example (illiquid long duration bonds), in order to truly reflect the repricing logic (lower treasury yields = marked up asset price), the liability side should also be repriced, should it not? The addition of the long duration asset required the addition of a long duration liability (or some equivalent disposition of assets, addition of duration mismatch risks, etc.) within the organization. Assuming the asset was sold in the valuation period, it follows that the financing mechanism would also be unwound, and the value of the unwinding likely changed through time with opposite sign but similar magnitude to the asset. What I'm suggesting is changes in overall environment (such as an implicit reduction in discount rate based on lower treasury yields) are largely offset on the financing side of the transaction, so balance sheet changes to the asset alone are misleading. Only when a material change occurs which can be demonstrably tied to the asset alone (such as an adverse credit event) should the asset value be changed. Returning to your simple example (illiquid long duration bonds), in order to truly reflect the repricing logic (lower treasury yields = marked up asset price), the liability side should also be repriced, should it not?

The addition of the long duration asset required the addition of a long duration liability (or some equivalent disposition of assets, addition of duration mismatch risks, etc.) within the organization. Assuming the asset was sold in the valuation period, it follows that the financing mechanism would also be unwound, and the value of the unwinding likely changed through time with opposite sign but similar magnitude to the asset.

What I’m suggesting is changes in overall environment (such as an implicit reduction in discount rate based on lower treasury yields) are largely offset on the financing side of the transaction, so balance sheet changes to the asset alone are misleading. Only when a material change occurs which can be demonstrably tied to the asset alone (such as an adverse credit event) should the asset value be changed.

]]> By: charles http://alephblog.com/2008/01/11/pandora-and-the-fair-value-accounting-rules/comment-page-1/#comment-16493 charles Mon, 14 Jan 2008 08:01:48 +0000 http://alephblog.com/2008/01/11/pandora-and-the-fair-value-accounting-rules/#comment-16493 Have a look at this old article from 1899 in the link below. Aside from the sadness of the demise of the term "corner" (despite the continued use of the term "cornering the market"), this article shows that there has been a long history of supply and demand imbalances in markets due to speculators. The flaw with current accounting direction (FAS157 etc.) is its lack of recognition of the degree to which markets are incomplete. Hence we are still seeing markets like ABS/CDS where a near monopolistic corner has developed with desparate financial institutions on one side being taken advantage of by speculating hedge funds. The resulting observable prices are surely not a better basis for accounting than a mark-to-model actuarial approach which would involve a more fundamental stochastic cash flow projections where cash flow variability is based on historical statistics for fundamental variables (house prices, etc.). http://www.econlib.org/Library/YPDBooks/Lalor/llCy979.html Have a look at this old article from 1899 in the link below. Aside from the sadness of the demise of the term “corner” (despite the continued use of the term “cornering the market”), this article shows that there has been a long history of supply and demand imbalances in markets due to speculators. The flaw with current accounting direction (FAS157 etc.) is its lack of recognition of the degree to which markets are incomplete. Hence we are still seeing markets like ABS/CDS where a near monopolistic corner has developed with desparate financial institutions on one side being taken advantage of by speculating hedge funds. The resulting observable prices are surely not a better basis for accounting than a mark-to-model actuarial approach which would involve a more fundamental stochastic cash flow projections where cash flow variability is based on historical statistics for fundamental variables (house prices, etc.).

http://www.econlib.org/Library/YPDBooks/Lalor/llCy979.html

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