Lessons from the financial crisis | 83 comments (83 topical, 0 editorial, 0 hidden)

Re: Lessons from the financial crisis (none / 1)

Well, states are still issuing bonds, but when it comes to loans, all kinds of public and private entities are financing themselves through bonds because those don't count as "debt". You thought that deal Goldman Sachs[*] structured for Greece was a one-off?

[*] Apparently Mario Draghi, the current frontrunner to succeed Trichet, was involved in this...

Economics is politics by other means

by Migeru (migeru at eurotrib dot com) on Thu Apr 21st, 2011 at 01:17:20 PM EST
[ Parent ]

Re: Lessons from the financial crisis (none / 1)

So you mean we have no idea about the general state of leverage in our business firms?

Wonderful.

This is legal for what precise reason, again?

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu Apr 21st, 2011 at 01:27:05 PM EST
[ Parent ]

Re: Lessons from the financial crisis (none / 0)

Which part of "off-balance-sheet liability" is hard to understand?

The problem is with accounting treatment of contingent liabilities.

Economics is politics by other means

by Migeru (migeru at eurotrib dot com) on Thu Apr 21st, 2011 at 01:39:19 PM EST
[ Parent ]

Re: Lessons from the financial crisis (none / 1)

In which alternative reality does it make sense to assume away contingent liabilities? Clearly, if you want to do reality-based accounting, you need to include all contingent liabilities as actual liabilities until and unless you can make a reasonable (as in actuarial) case that either

a) the contingency that would turn the contingent liability into an actual liability will not occur or

b) you have enough uncorrelated [NB! losses on financial assets can never be assumed to be uncorrelated] assets to simply apply a uniform haircut.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu Apr 21st, 2011 at 02:15:01 PM EST
[ Parent ]

Re: Lessons from the financial crisis (4.00 / 2)

Financial reality is consensual. You're the one living in an alternative reality since this here reality is defined by the currently agreed accounting practices.

Yeah, this probably means we're FUBAR.

Economics is politics by other means

by Migeru (migeru at eurotrib dot com) on Thu Apr 21st, 2011 at 02:22:19 PM EST
[ Parent ]

Re: Lessons from the financial crisis (none / 0)

But the accounting principles are supposed to be based on the convention that assets are income-generating property, or property with significant resale value, while liabilities are payments that will come due at some future date. The current treatment of contingent liabilities is inconsistent with that principle (as we have just seen).

Incidentally, if I remember my accounting class right, in the Danish version of reality you have to book the full expected value of your contingent liabilities. And I don't think inability to estimate the probability that the contingency occurs will allow you to set the expected value to zero...

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu Apr 21st, 2011 at 02:55:56 PM EST
[ Parent ]

Re: Lessons from the financial crisis (none / 0)

Incidentally, if I remember my accounting class right, in the Danish version of reality you have to book the full expected value of your contingent liabilities.

Either

that is inconsistent with mark-to-market accounting or equal to it by definition; or
expected value could be zero with a large dispersion in either direction

Regarding 2) suppose you have booked the expected value. You now have a contingent liability and a contingent asset, where only one of the two can be nonzero at any given time. How do you book that?

Economics is politics by other means

by Migeru (migeru at eurotrib dot com) on Thu Apr 21st, 2011 at 04:22:05 PM EST
[ Parent ]

Re: Lessons from the financial crisis (none / 1)

Ad 1) No. Where there exists a secondary market for contingent liabilities, it is permissible to mark them to market, as one would be able to repurchase them at the market discount.

Where there is no secondary market, however, it is not possible to mark to market. Thus no convention can be inconsistent with the mark-to-market convention. Mark-to-market returns NAN, so any valuation convention which is politically palatable may be applied to illiquid liabilities.

"NAN" is not the same as "zero." This last point is the one that seems to have caused some confusion with AIG et al.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sun Apr 24th, 2011 at 07:24:49 PM EST
[ Parent ]

Then the systemic problem lies with the auditors (4.00 / 3)

who consent to play mind games with contingent liabilities for the (short-term) benefit of their clients, thereby abandoning any pretense of professional ethics.

and it's a cultural problem : much as doctors, for example, are presumed for cultural or historic reasons to always put the health of their patients first, we are expected to credit auditors with impeccable ethics and morals.

But these are not individual professionals who might suffer in reputation or income if they make bad calls on contingent liabilities. They are corporations which are often intimately bound with the entities they audit. So we add moral hazard to arm's length issues.

_{It is rightly acknowledged that people of faith have no monopoly of virtue
- Queen Elizabeth II}

by eurogreen on Fri Apr 22nd, 2011 at 03:44:41 AM EST
[ Parent ]

Re: Then the systemic problem lies with the (4.00 / 3)

Also, when a doctor fucks up, people die in front of him and between his hands. When an auditor fucks up, people he's never met and whom he needn't care about die because they are deprived of the ability to see a doctor in the first place.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Apr 22nd, 2011 at 07:32:42 AM EST
[ Parent ]

Re: Then the systemic problem lies with the (none / 0)

Genocide by accounting fraud and stupid, special interest serving policies, such as corn ethanol fuel.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Fri Apr 22nd, 2011 at 09:51:40 PM EST
[ Parent ]

Re: Lessons from the financial crisis (none / 0)

all kinds of public and private entities are financing themselves through bonds because those don't count as "debt".

Has this been enshrined in Generally Accepted Accounting Practices? Is the coupon now an expense and the bond an asset to the corporation? And is this the practice in most countries?

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Apr 21st, 2011 at 01:39:57 PM EST
[ Parent ]

Re: Lessons from the financial crisis (none / 1)

Gah, I mean derivatives!

Economics is politics by other means

by Migeru (migeru at eurotrib dot com) on Thu Apr 21st, 2011 at 01:41:56 PM EST
[ Parent ]

Re: Lessons from the financial crisis (none / 0)

You were bending my head out of shape. :-) So the proceeds of selling the bond constitute assets and the bond itself a liability? (Unlike Jake I never took accounting.)

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Apr 21st, 2011 at 05:03:58 PM EST
[ Parent ]

Re: Lessons from the financial crisis (none / 0)

Forget what I typed about bonds and restart here:

The financial system has move(d) on f(ro)m loans to derivatives as means of financing.
Thus default would be on derivatives?

Well, states are still issuing bonds, but when it comes to loans, all kinds of public and private entities are financing themselves through ~~bonds~~derivatives because those don't count as "debt". You thought that deal Goldman Sachs structured for Greece was a one-off?

Economics is politics by other means

by Migeru (migeru at eurotrib dot com) on Thu Apr 21st, 2011 at 05:24:36 PM EST
[ Parent ]

Don't get me started on GAAP (none / 1)

Footnotes [to financial statements] also contain disclosures relating to contingent losses. Firms are required to accrue a loss (recognize a balance sheet liability) when both of the following conditions are met:

It is probable that assets have been impaired or a liability has been incurred.

The amount of the loss can be reasonably estimated.

If the loss amount lies within a range, the most likely amount should be accrued. When no amount in the range is a better estimate, the firm may report the minimum amount in the range.
SFAS (Statement of Financial Accounting Standards) 5 defines probable events are those "more likely than not" to occur, suggesting that a probability of more than 50% requires recognition of a loss. However, in practice, firms generally report contingencies as losses only when the probability of loss is significantly higher.
Footnote disclosure of (unrecognized) loss contingencies is required when it is reasonable possible (more than remote but less than probable) that a loss has been incurred or when it is probable that a loss has occurred but the amount cannot be reasonably estimated. The standard provides an extensive discussion of loss contingencies.

(Gah)

Economics is politics by other means

by Migeru (migeru at eurotrib dot com) on Thu Apr 21st, 2011 at 01:46:52 PM EST
[ Parent ]

Re: Don't get me started on GAAP (4.00 / 2)

SFAS (Statement of Financial Accounting Standards) 5 defines probable events are those "more likely than not" to occur, suggesting that a probability of more than 50% requires recognition of a loss. However, in practice, firms generally report contingencies as losses only when the probability of loss is significantly higher.

Translation: Firms generally report contingencies as losses when irrefutable evidence of a loss has made its way into the public domain and can no longer be obfuscated by contrary pronouncements and obsfuscation -- if then.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Apr 21st, 2011 at 08:34:17 PM EST
[ Parent ]

Re: Lessons from the financial crisis (none / 1)

financing themselves through ~~bonds~~derivatives

Gah.

Economics is politics by other means

by Migeru (migeru at eurotrib dot com) on Thu Apr 21st, 2011 at 01:40:48 PM EST
[ Parent ]

Lessons from the financial crisis | 83 comments (83 topical, 0 editorial, 0 hidden)

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