Friday, October 03, 2008

From Under the Green Eyeshade


As an official bean counter (or accountant for those who want to be formal about it) I cringe as I listen to some of the stuff that’s being said with regard to the bailout.

The most galling thing I’ve heard so far is what seems to have started bubbling up over the last couple of days as certain factions have questioned the validity of the “mark to market” accounting rules that require investments to be valued at current market value. While I have no intention of getting into an in depth study here of the details of the rules (although goodness knows it would be a great cure for insomnia for you to try to read something like that) I just need to say something about the whole issue before my head explodes.

There are various ways you might account for investments in securities:

Cost – This would be the most simplistic, but highly inaccurate in some, if not a lot, of cases. You buy a stock for $1,000 you include it in the assets on your balance sheet at $1,000. What this doesn’t do is take into account any fluctuations in the value of that asset over time. Therefore, anyone looking at your balance sheet is going to have no idea whether it fairly represents your financial position. I doubt there’s much of anybody who would argue for valuing investments in securities at cost.

Lower of Cost or Market – Ah, this is an old favorite. In this case if you buy a stock for $1,000 you carry it on the books at $1,000 unless the value falls below $1,000, in which case you write it down to its market value. Therefore, if the stock value rises to $1,200 the stock will still appear on your books at $1,000, but if the stock value falls to $800 it will appear on your books at $800. This is a nice conservative way of accounting. Accountants liked it because it meant you weren’t over inflating values on your balance sheet and making you look like you’ve got more than you have. On the other hand, if you happen to be really good at picking stocks, then over time it starts to look like you have less than you actually do. Because after buying that $1,000 of Really Good Company early on and holding it several years that same stock is worth $5,000, but you only get credit for 20% of that. The only way to recognize that $4,000 gain is to sell the stock and actually realize it. I grew up in the era of Lower of Cost or Market and will admit to having a bit of an affinity for it. When it comes to reporting financial position I’m all about erring on the side of understatement of assets and overstatement of liabilities. I’m just cautious that way.

Mark to Market – The simplistic definition of this would be that for every investment you value it at its current market value. The danger of this is that it makes you vulnerable to market swings more than the previous method. The benefit is that it makes for a “truer” assessment of the value of your portfolio at a point in time. Lots of people in the financial industry lobbied hard to get this into GAAP (Generally Accepted Accounting Principles) when times were good. They wanted to take advantage of the high values in the stock market at the time. Now these same people are crying in their beer because times ain’t so good and instead of having to mark their investment from $1,000 to $800 as they would have under Lower of Cost or Market and taking a $200 hit they have to mark their investment from $5,000 to $800 taking a $4,200 hit. This is exactly why I favor Lower of Cost or Market. Mark to Market has allowed companies to inflate their balance sheets for far too long.

Now these bigwigs in high finance want to ditch Mark to Market. But do they want to return to Lower of Cost or Market to help return towards a bit more conservative sanity? NO! They want even more freedom to mark invested assets up to some other value as determined by them. If we were to allow these people that kind of power there would be little to no integrity in financial reporting at all. I can’t imagine that this will ever come to be, but if it does I guarantee you I will pull out of the stock market all together because financial statements will be even more meaningless than they already are.

I could go on, but I won’t. I could expand on several points here, but I won’t. I could offer more options and examples, but I won’t. I know I’ve already left most, if not all, of you with your eyes glazed over.

Grrr…. This kind of stuff just riles me up like few things can. It’s all about integrity, choosing integrity over greed, choosing to do the right thing for everyone rather than the thing that will make it great for me while screwing over the masses. Less regulations and looser regulations just allow the greed to run rampant, unchecked. It’s bad enough already. How much worse does it have to get before regular people start to fight back?

Damn I’m pissed off.

3 comments:

Serenity said...

I tried, hon, i really tried, to read every word, but my pea brain kept wandering away and i couldn't keep it on task. I'm glad you understand what's going on and the backstory of all of it. I'm just-- oh look, shiny!!
Sigh.

BJ said...

Oh gosh I think someone with a Master's in Accountancy from a Big 10 university would have a good grasp on the financial issues of the day, don't you?
*rolls eyes*

Trueself said...

I had a real snarky comment all written out and almost hit "Publish your comment."

Then I thought better of it.

So I'll just say here thanks BJ for coming to my defense.