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Wednesday Open Thread | 69 comments (69 topical, editorial, 0 hidden)
Re: Massive accounting fail (none / 1)
Holding To Account
Own Credit CVA

Now what about Citi? It has the same pricing model as GS, which calculates a FV of $1m. So surely C recognises a financial liability of $1m? No. Again, accounting standards differ slightly in wording, but in principal the fair value of a liability is the price at which an entity could extinguish any future obligations, in an arm's length transaction. I.e. "What price would a counterparty be willing to cancel/settle the trade at now. Well, we have seen above that GS, and probably the rest of the market, would accept $700k to cancel the deal. So, Citi gets to write the liability down to $700k. In accounting terms:

DR Financial Liabilities $300k

CR Principal Transactions $300k

Yes, you have read it correctly - Citi has made a profit of $300k as a result of becoming less creditworthy!!! In accounting/industry spreak, Citi has made an Own Credit CVA of $300k.
Read the whole post.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Carrie (migeru at eurotrib dot com) on Wed Apr 22nd, 2009 at 04:15:04 PM EST
[ Parent ]
Re: Massive accounting fail (4.00 / 2)
That's what "mark-to-what-you-feel-like" is all about: use the rules in full when they are to your advantage, and relax them when they aren't.

Some banks have actually been buying up their own bonds (for amounts less than their full face value), so it's not completely cut off from reality.

And think of when companies make losses - they suddenly get to pay less taxes, which ends up increasing their net profit is they can deduct these losses from significant earlier (or book provisions for later) gains...

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Wed Apr 22nd, 2009 at 04:30:25 PM EST
[ Parent ]
Re: Massive accounting fail (none / 0)
Jerome a Paris:
Some banks have actually been buying up their own bonds (for amounts less than their full face value), so it's not completely cut off from reality.
So these counterintuitive profits from deteriorating creditworthiness are an instance of overhedging.

These accounting rules attempt to make balance sheets neutral to credit risk. But if the market overprices credit risk the CVA correction overshoots and you get a net profit from deteriorating credit.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith

by Carrie (migeru at eurotrib dot com) on Thu Apr 23rd, 2009 at 04:49:56 AM EST
[ Parent ]

Wednesday Open Thread | 69 comments (69 topical, 0 editorial, 0 hidden)
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