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An unstable house of (derivative) cards...

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Senior Manager
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Joined: 30 Jul 2007
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An unstable house of (derivative) cards... [#permalink] New post 23 May 2008, 14:28
The following proposal is absolutely ridiculous. When the big time money faces trouble as their OTC derivatives go sour, they now have the audacity to request a change to the rules of the game?!

The market turmoil is exactly as it should be: to wipe out the excesses of a credit-induced, over-leveraged financial orgy of epic proportions. The more the inevitable depression is postponed, the worse it is going to be for everyone.


http://www.ft.com/cms/s/0/07cb8b1a-275e ... 07658.html

Top banks call for relaxed writedown rules

By Francesco Guerrera in New York and Jennifer Hughes in London

Published: May 21 2008 23:04 | Last updated: May 21 2008 23:04

The world’s leading banks have stepped up pressure to relax controversial accounting rules with a new plan aimed at breaking the “downward spiral” of huge writedowns, emergency fundraisings and fire-sales of assets.

The proposals on “fair value” accounting by the Institute of International Finance, an alliance of 300-plus companies chaired by Josef Ackermann, Deutsche Bank’s chairman, would enable financial companies to cushion the blow of financial crises by valuing illiquid assets using historical, rather than market, prices.

Under the plan, which has been obtained by the Financial Times, banks that decided to keep assets on their balance sheet would also be freed from the requirement to hold them to maturity and would be able to sell them after two years.

The IIF’s proposals, which were sent to US and European central banks, governments and accounting watchdogs, underline financial groups’ view that the credit crunch will inflict long-lasting damage on their business.

The IIF’s paper says: “The writedowns required under current interpretations may be substantially in excess of any actual or reasonably probable loss on many instruments”.

Financial companies around the world have been hit by more than $300bn in writedowns and been forced to raise more than $260bn from outside investors since last year, according to Bank of America analysts.

Senior bankers have long sought a change to the accounting rules, arguing that the requirement to mark the value of assets to the market price even when markets are illiquid or frozen creates a vicious circle of excessive losses, capital depletion and forced asset sales.

“Often dramatic writedowns of sound investments required under the current implementation of fair-value accounting adversely affect market sentiment, in turn leading to further writedowns...in a downward spiral that may lead to large-scale fire sales of assets,” the IIF’s paper argues.

However, accounting standard-setters in the US and Europe so far resisted pressure to relax fair value rules. Other regulators have also criticised financial companies for proposing rule changes that would reduce the impact of a crisis triggered in large part by their aggressive lending and underwriting practices. The IIF declined to comment.
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Re: An unstable house of (derivative) cards... [#permalink] New post 28 May 2008, 12:50
I actually agree with the proposal to some extent. I think a lot of these assets have had to be written down further than necessary because the market has dried up. These products (i'm mostly talking about ABS and MBS here) are seen as so toxic that nobody wants to buy them and that is depressing market prices to below intrinsic value. Just like stocks can drop below market value in a panic, so can MBS and ABS. I think if you actually valued some of these securities by projecting future cash flows (as uncertain as those are) and then discounted them back to present value (at a very high rate to account for the risk in not receiving those cash flows) you would end up with a much higher value than these market prices which the writedowns are based on. If I have an asset that will pay me $10 next year with reasonable certainty, just because the market says its worth $1 becuase they don't like that asset class does not mean its really worth $1.
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Re: An unstable house of (derivative) cards... [#permalink] New post 28 May 2008, 14:30
IHateTheGMAT wrote:
I actually agree with the proposal to some extent. I think a lot of these assets have had to be written down further than necessary because the market has dried up. These products (i'm mostly talking about ABS and MBS here) are seen as so toxic that nobody wants to buy them and that is depressing market prices to below intrinsic value. Just like stocks can drop below market value in a panic, so can MBS and ABS. I think if you actually valued some of these securities by projecting future cash flows (as uncertain as those are) and then discounted them back to present value (at a very high rate to account for the risk in not receiving those cash flows) you would end up with a much higher value than these market prices which the writedowns are based on. If I have an asset that will pay me $10 next year with reasonable certainty, just because the market says its worth $1 becuase they don't like that asset class does not mean its really worth $1.


The market determines the price. And at the moment, there is no market for these products.

If you are brave enough to see value in these products, then of course you buy. But, who is buying?

Supply and demand.

The US economy is rolling over bigtime. People are losing their jobs, have massive amounts of debt, and are losing their homes. Economic activity has contracted considerably, and we are probably in recession. The dollar is in the middle of a currency crisis, yet interest rates are at near all-time lows. The FED cannot raise interest rates, else the stock markets tank bigtime and they further pinch homeowners who are just getting by on their ARMs. The stock markets are about the only thing that is keeping hope alive for those with investments in US-listed securities, yet it appears that we are still in a bear market and may have further down to go.

The US government needs an appreciating stock market in order to extract capital gains tax from investors to fund the massive liabilities and debts of wars, social security, and various other government programs.

The USA's balance sheet is absolutely disgusting. If the USA were a company listed on a stock exchange, would you buy it? Oh, I'm sorry, it already is listed on an exchange: the foreign exchange market, i.e. the US dollar.

The world has lost faith in the US dollar as the reserve currency, as evidenced by the 40%+ decline since 2000. Further depreciation of the dollar will raise the cost of nearly all consumer goods. Unless salaries rise to compensate the ensuing inflation that is coming, then we are looking at textbook stagflation.

The US isn't pulling out of Iraq or Afghanistan anytime soon. This will further add on to the massive deficit.

The market has determined that the management of USA, Inc. is horrible. Until the market changes its mind, the value of USA, Inc. will continue to head down. I don't see the market changing its mind even with Obama or Clinton in charge.
Re: An unstable house of (derivative) cards...   [#permalink] 28 May 2008, 14:30
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