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Bull**** is now allowed in financial statements


Partner24
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I own a business, it's not publicly traded. It earns say $100,000 per year. There is no market for it, nobody is interested. Some wacko offered me $50,000 for it. Do I report my business as worth $50k? To be honest, I like some aspects of this accounting change. Market values are not some sacred thing, the more irrational the market values, the more nonsensical they are and like Graham's Mr. Market, we would do best to ignore that valuation. That doesn't mean values should be inflated either.

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I loved Munger's response to the following question:

 

Can you comment on EBITDA (earnings before interest, tax, depreciation and amortisation)?

 

Munger: Every time you see the word EBITDA in a presentation, you should replace it with BULLSHIT EARNINGS, because that's what they are!

 

Buffett: Yeah, why not put all expenses in the footnotes and say that "sales equals profits". Depreciation is real and it's the worst kind of expense. They will, as depreciable assets, need to be replaced.

 

 

I've heard all about how MTM accounting caused in large part the financial turmoil in which we are now embroiled. I would argue that MTM simply enabled us to better see the financial turmoil.

 

-Crip

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It never made sense to report the last round lot trade of the quarter/ year as the accounting value of an asset.  As soon as the number is put to paper it is wrong.  Problem is that model/cost accounting is just as flawed, and equally susceptible to gaming.

 

 

Investors will always be left with the responsibility to determine the intrinsic value of assets on their own.  No formula, model can be developed that will accurately tell you what someone else will pay you for an asset.  Of course that doesn't mean formulas won't be developed and sold as the end all be all. 

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I own a business, it's not publicly traded. It earns say $100,000 per year. There is no market for it, nobody is interested. Some wacko offered me $50,000 for it. Do I report my business as worth $50k? To be honest, I like some aspects of this accounting change. Market values are not some sacred thing, the more irrational the market values, the more nonsensical they are and like Graham's Mr. Market, we would do best to ignore that valuation. That doesn't mean values should be inflated either.

 

You're talking about the bid.  A more accurate analogy would be that some wacko owns 10% of your business and decides to sell 1% for $500.  At that point MTM would say that the whole business is worth 50k. 

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I could never really understand the value of MTM accounting.  It wrongly skews the financial statement in good times and bad times.  It simply adds volatility.  Canada only went to MTM two or three years ago.  

 

I also dont see how it contributed to the downfall of the banking system.  Once the defaults started with MB securities then the market no longer had a market for them at all.  So they became marked to estimate.  If a market could actually be generated it may have proven better since there was still value in many of these securities.  

 

I agree with Oldye; It is up to us to analyze the numbers or steer clear when they are incomprehensible.  

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3 basic views to this:

 

Narrow view: At any given time the asset is worth what someone else just paid for it. As evidenced by the last (recent) trade, or what it can be shown to be worth had it traded. The accounting rules lay out what 'recent' is, & specify the order in which you take the price. Unambigious, liquidation value - today.

 

Broad view: The asset is worth what a willing buyer/seller are willing to exchange it at in an orderly sale process; ie: if the other guy was forced to fire sale the asset I don't have to use that price because I'm not willing to sell at that. Accounting rules become wide open to manipulation. (1) Buy a zero coupon bond today at 25, but value it at 100. Because I intend to hold it to maturity, & it will be worth 100 when it eventually matures. (2) My mortgage is 100, my neighbours house just sold at 60, but I'll value at 130. Because I intend to hold onto to it for another 10 yrs & at that point I expect it to be worth 150. 150 discounted at todays discount rate of 'x', produces a PV of 130.

 

IFRS View: The narrow view approach but it effectively 'warehouses' most of the periodic MTM in Other Comprehensive Income (equity in GAAP terms) untill the asset actually gets sold (the cummulative MTM then passing through income in GAAP terms). However IFRS also requires a very full & rigorous disclosure of what's in Other Comprehensive Income, including its sensitivity to some of the major variables.

 

So ... what was really being implied is 

- We can't get to year-end unless we can fudge the numbers ?

- The true losses are so bad that if we actually came clean we'd trigger a depression ?

 

Hardly surprising there was a split decision.

 

SD

 

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MTM figure is inherently flawed and as Uccmal correctly states it tends to skew results further in good times and bad.  Sort of a legitimized incorporation of folly in both directions.  I believe the main reason for MTMs implementation in the first place was to keep individual greed and incentive bias off the financial statements but the results are less than perfect.  

 

That said, this looks like a powerful tool for capitalizing on Mr Market's folly prices against our own IV calculations, the epitome of which has been kindly demonstrated to us by the circus surrounding Berkshire's Equity Puts.

 

Find the MTM figures in the financial statements (the bigger the better), determine the direction they will accelerate Mr Market's folly and position yourself accordingly.

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What I am gathering from some of the discussion is that we should be forced to look into the financial statements of companies that we own, as a part of analyzing their books... Not that there is anything wrong with that-we need to look into the books.

 

It seems to me that the financial statements should be as transparent as possible-especially when being given to the owners of the company-maybe publish balance sheets and income statements with an asterisk that says "HEY, LOOK AT ME! these assets were worth x when we bought them, but if we were to liquidate them right now, would probably sell for y."

 

I have always been astonished that a mere accounting rule, that before taxes, doesn't actually change the intrinsic value of a business-should be thought to fix the banking industry's problems...

 

Charlie Munger: "when you mix raisins with turds, you still have turds."

 

 

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There is a difference between not being a market for certain "assets", and the owner not liking what the market is willing to pay for those assets.    There are plenty of people willing and able to buy some of these distressed securities, but the owners just don't like the bid.   

 

I also thought the idea behind capital ratios was that the banks had liquid assets to back their loans.  If there really is no market, then those assets shouldn't be allowed to count towards their tier 1 ratio.

 

Unfortunately it's become abundantly clear that the taxpayer will end up covering any difference between the marked value and actual realized value.    Heads they win, tails you lose.

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I suspect there would be a lot of nudges/winks in these "deals".  So now we may be entering a new shell game where we will need to guess where the toxic assets are at any one given time.  The insanity never ends.

 

Bailed-out banks may buy toxic assets

 

"U.S. banks that have received government aid, including Citigroup Inc, Goldman Sachs, Morgan Stanley and JPMorgan Chase & Co, are considering buying toxic assets to be sold by rivals under the Treasury's $1,000 billion plan to revive the financial system, the Financial Times said.

 

Citigroup was considering whether to take part in the plan as a seller, buyer or manager of the assets, but no decision had yet been taken, the paper said, citing people close to the company....

 

The U.S. government's plan, known as the Public-Private Investment Program, gives government help to private investors looking to buy loans and securities from banks.

 

"It's an open program designed to get markets going," a Treasury official told the paper, adding that "it is between a bank and their supervisor whether they are healthy enough to acquire assets."

 

 

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I really miss the "lower of cost or market" concept. It sure took a lot of the "fudge" or BS out of the equation.

 

And if there is no market, then cost is the correct accounting treatment? This whole thing hinges on the definition of a 'market'. Does 1 crazy bid make a market? How about 2 crazy bids? The idea of *economic* value seems closer to a fair assessment of value - as long as the holders of these assets don't cheat!

 

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The idea of *economic* value seems closer to a fair assessment of value - as long as the holders of these assets don't cheat!

 

That is the point, IMHO, that when the results of "cheating" for senior executives of corporations ends up producing obscenely-sized bonuses, then human nature and history clearly shows that cheating will occur. I remember Warren and Charley talking about derivatives years ago where, due to the complexity, both sides in a transaction could (and did) calculate that they both had unrealized gains on OPPOSING ENDS OF A TRADE. This is completely insane. So, we have to create an imperfect regulation (MTM) in order to stop cheating.

 

 

You're talking about the bid.  A more accurate analogy would be that some wacko owns 10% of your business and decides to sell 1% for $500.  At that point MTM would say that the whole business is worth 50k. 

 

Oldye, I see your point but I see that as a very remote possibility. What I do see as possible is a friend of your wacko who shorts the hell out of your business (legally or otherwise) and then your wacko does his thing. MTM does allow for that kind of manipulation and likely others. So, how do we dissuade this? Enforcement with some stern-ass penalties would be a good step. Maybe we could create a commission to do this...a commission which would look over securities and exchanges. We could call them the Exchange and Securities Commossion. That would be a great idea. Of course, this commission would need to be above reproach and the individuals working there would need to be first and foremost concerned with the well being of the markets and not the major Wall Street Firms from whom they hope to get jobs in the future. But that would really be cool.

 

It all makes me want to vomit.

 

-Crip

 

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