Flawed Accounting

What are mortgage backed securities really worth? Is the decline in value "other than temporary"?

Accountants, auditors and managers are struggling to find answers to these and other related questions. At any specific point in time, an asset is only worth what someone is willing to pay for it. Or is it? Suppose I'm shopping for a used car and I find two virtually identical cars that fit my needs exactly. One is owned by someone who is desperately trying to raise cash to meet some critical family obligations. The other is owned by a large auto dealership. Where will I be able to make the best deal (i.e., the lowest price)? If I can buy the car for $1,000 less from one source than the other, does that mean the other seller has it overpriced?

If, instead of cars, I was buying financial instruments (securities, loans, etc.) the entity that was left with the unsold security would be forced to write it down to the "market" price based on what I paid.

In addition, if my accountants and auditors decided the "market" price decline was "other than temporary" I would not be permitted to adjust the price upward even if the market price doubled. The only way to recover my loss would be to actually sell the asset.

If you assume "other than temporary" is just accounting language for "permanent," you would be wrong. "Other than temporary" in accounting terminology generally means the value isn't expected to recover within a short period of time (i.e., a week, a month, etc,).

Guess what happens when "Big Broker" sells securities to raise cash. The impact of "fire sale" pricing spreads through the market.

Accountants and auditors aren't valuation experts and they are not able to accurately forecast future events. Current accounting rules assume accountants can determine whether an asset has been accurately valued and whether that value is likely to appreciate in the near future. Accountants and auditors are great at following rules, so we sometimes get accounting results that are absolutely accurate according to the rules, but may not reflect reality.

There's an old story about a person who went up in a hot air balloon and got lost. After drifting around at a high altitude for several hours, he finally spotted an open space and managed to land. As he landed, he noticed a man watching the balloon come down so he yelled out, "Where am I?" The man replied, "You're in a hot air balloon making a landing on a practically deserted beach." The man's answer was absolutely correct, but of no value to the person in the balloon.

Let's make our accounting both accurate and relevant.