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Sunday, April 4, 2010
How much is a financial capital asset really worth? Fantasy accounting.
Two bloggers today took on this question. The first, Steve Waldman, built on the Frank Portnoy video piece that we watched last Tuesday and concluded that not only do we not know the answer, we never can price a financial asset with certainty. See here for Waldman's reasoning. The second blogger wrote about the suspension of "mark to market" accounting rules which has allowed banks to keep financial assets on their books valued at the purchase price and not the market price thus, making Waldman's concern about the real value of financial assets meaningless for today's banks. The way it works is this: suppose I bought a mortgage-backed security in 2007 for $1000. I keep it on my books as an asset at a value of $1000. This security would sell for 50 cents in the market today but I don't have to acknowledge that fact anywhere. See here.
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First, mark to market accounting, or a version of it, is what allowed Enron to "earn" huge profits for over a decade while actually hemorrhaging money.
ReplyDeleteSecond, I agree with the argument that these assets simply can not be priced. Many of them are loosely tied to the real value they represent and those connections are so convoluted that even investing firms couldn't trace them all the way back to their root values.