Assorted links

Regarding “the corruption of accounting standards,” I think this is
hysterical headline for a seriously misleading article. The combo
of Basel II capital requirements and mark to marketing accounting
standards rigidly applied has been very unfortunate in the current crisis.
Allowing banks to value assets to be held to term at cost is a reasonable
and wise move.

Debit,
Investors benefit from fair value accounting standards, although the switch from historic value to fair value can lead to less useful results during the period of change (when investors are basing expectations on results generated under historic value/accurals with results currently generated under fair value).

More importantly capital (leverage) standards based on fair value tend to swing to dramatically to be useful, a capital standard that can double in a day reflects poor management but isn’t useful for the government to manage it’s risk either.

nelsonal:

I agree that accounting information can be less meaningful from a comparative perspective when new principles are applied. However, fair value accounting for financial assets has been with us since ~1993 due in part to investment companies playing games with their valuation models. Accounting standards do provide flexibility for difficult to value assets, particularly when prices are not available in active markets. Under these circumstances discounted cash flow models are permitted and encouraged, although many audit firms may have concerns signing-off on non-market based valuations due to the subjectivity involved.

barkley:

Thanks for your comments. I agree that accounting can be more art than science and there are reasonable approaches to valuing financial assets. In order for historic cost accounting to make sense, we would need to demonstrate the following:

1. That the financial assets held by institutions did not experience a non-recoverable decline in fair value.

2. That the financial institutions had both the intent and ability to hold the financial assets until maturity.

As to 1., given the nature of their subprime investments, the issue is really how much of their initial investment will be recovered. If the amount is less than 100%, then accounting for these assets at cost is fundamentally deceptive.

As to 2., if these financial institutions do not have the intent and ability to hold to maturity, which appears to be the case in many instances, then assuming otherwise does not appear to be a reasonable proposition.

I think that far too many people have focused on the accounting standards instead of focusing on the extremely poor business decisions made by these institutions. Red herring?