The news that risk models at AIG and other Wall Street firms failed to measure risk of collateral calls or write downs may explain the animosity many top executives have expressed for mark to market accounting. If it wasn’t in their models, it shouldn’t exist.
Mark to market accounting can force firms to write down the value of assets that fall into disfavor with investors. Under older accounting rules, firms may have carried the assets at higher values based on the expected income they produced under computer models based on historical performance. Critics of the old rules say using market prices give a better snap shot of a firm’s financial health and better reflect changes in available information, especially when markets break out of historical patterns.
Many Wall Street executives have criticised mark to market rules, arguing that they unfairly apply only to certain firms and force them to mark down assets to prices depressed to unrealistic, panicked levels. Of course, we didn’t hear much from these guys about the dangers of mark to market before they got crushed by declining asset values, massive write downs and the need to dilute shareholders through private and government capital injections.
This morning’s news may shed some light on the new hatred of mark to market. Basically, Wall Street feels ambushed. Many firms didn’t include the write down risk in their financial models, which they treated as the truest guide to the way the world worked. Phenomenon not modelled was referred to as “market misbehavior,” as if it were the market rather than the models that were wrong.
So since banks and insurance companies weren’t modelling for write down risk, it shouldn’t have existed. That kind of bulwark against reality, however, seems to have collapsed. Thank goodness we now have the government’s capital purchase plan and the TARP to rebuild our bridge to unreality.
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