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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 ]
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 ]
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 ]
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

  1. that is inconsistent with mark-to-market accounting or equal to it by definition; or
  2. 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 ]
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 ]
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 ]
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 ]
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 ]

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