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« FAS 157 and Marking to Market | Main | The Fed Minutes: An Answer to the Question of "Duping" »

February 19, 2008



Chris -

Thanks for a very thoughtful comment. It helped to inspire today's article.

It would be nice if some of those who highlighted the bad predictions of the past revisited those stories, but I am not holding my breath!


Chris Tinker

I think the problem lies less with the failure to understand the complexities of FAS157 than with the broader market willingness to unquestioningly accept explanations of directional risk - ESPECIALLY when it is presented in the context of complex valuation issues. The Y2K bug and the introduction of FAS157 into market parlance both served a common purpose - to "rationalise" a commonly presented view as soundly researched and therefore unchallengable as fact. Level 3 assets were regarded as trash precisely because their precise definition was too complex and it happened to fit the zeitgeist of the time - that the banks and Hedge Funds were in an EVEN BIGGER HOLE than we thought. Yet when, 3 months or so later you highlight that they told you no such thing and that the issue is interesting in the sense of what opportunities that may provide - well the ship had moved on. We no longer regard ourselves as on the edge of the abyss so - no interest. The real frustration is for those of us who pointed it out at the time - to a greater or lesser degree - but had to sit back and watch the Charlie Gasparino's of this world hector the investment community with their "certainties" of fact and see markets selling off further on the basis of little more than scaremongering and rumour. I guess they are doing their jobs - never letting the truth get in the way of a good story - but it is irksome none the less.


How do you think fair value was calculated before FAS 157?

Fair value isn't new. You are just hearing about it more because of the wider disclosure required by the standard.

If anything it has increased consistency because of the focus of regulators. The first part of FAS157 says it all, the standard does not require any new fair value measurements.

If you want to get to the accounting standard that matters, it is the accounting standard that allows a company to fair value complex investments... FAS157 just tells you how much BS is mixed in the pot. Did you like it better when that was just hidden behind the scenes? Maybe FAS157 has just woken everyone up to the fact that they've leveraged up on BS equity for the last 5 years. I'd stop trading too.

To point in the correct direction: FAS140 allows gain on sale for asset transfers (securitizations) and generated most of the originators profits. FAS115 allows you to mark to market securities. Somehow we all bought off on the idea that a securitization locks in a profit (gain on sale) and transforms a loan into a security (and hence mark to market accounting).

For what it is worth, IFRS has a similar framework.

David Merkel

Two notes on accounting:

1) When a standard becomes so complex that most professionals have a hard time with it, typically companies in that industry tend to see earnings and book multiples sag. Opaqueness gets a discount, except during manias.

2) On average, new accounting rules typically don't affect the prices of stocks much because free cash flows are typically unaffected by accounting rules.

Finally, an aside -- I didn't like FAS 157 or FAS 159 much because they lessen comparability across companies... an argument that Marty Whitman made as well.

But, that's been the consistent direction of FASB over the last 20 years, so maybe we should just scrap the whole thing and move to the international standards, even though it will give us a new set of flaws -- no accounting standard is ever perfectly complete or consistent, and angels are not applying the rules or principles.

Mike C

"Quite frankly, we hoped and expected that this would generate some interest and comment. Wrong! What were we thinking?

We checked this with our own small focus group and got a big yawn. No one wants to think about FAS 157. It is over the barrier of complexity. If things get too technical, everyone tunes out, no matter how important the topic.

The focus group was correct. We pay little attention to daily traffic at "A Dash" since we are not doing advertising, but we do periodic checks to see what resonates. FAS 157 causes eyes to glaze over. No one cares."


In my opinion, there is ***SO MUCH*** that can be learned from Warren Buffett and his investment career, and he freely shares his wisdom with investors.

He has a concept of "circle of competence". In my opinion, most investors either vastly overestimate their circle of competence, or routinely stray well beyond it in the investment decisions they make. Furthermore, I think this is one of the reasons for many investors underperformance. They do not know what they do not know nor have any hope of truly understanding.

Buffett also has a concept he calls his "too hard pile". These are potential investment opportunities that are simply "too hard" to ascertain what if any edge exists. For Buffett, the "opportunity" of tech stocks in general fall into this pile. That is OK, because he can go make a ton of money elsewhere, and has done so.

For me, Level 3 assets, FAS 157, mark to market versus mark to model, and whether AIG is a compelling opportunity or sitting on a time bomb of potentially worthless assets is well beyond my "circle of competence" and something I immediately throw in the too hard pile.

For me, thats OK, because as an example, I can stick to my natural gas E&P stock I completely understand (Chesapeake Energy-10% allocation) which once again closed at an all-time high and is still substantially undervalued.

I did not comment on the post because I had absolutely nothing of value to add. I thought your post provided an alternative perspective which again serves the purpose of bringing balance to the discussion. Any comment on my part would have been noise.

I think more then any other principle, investors (especially amateur individuals) would be best served to figure out and stick to their "circle of competence" which might be something like a pure lazy ETF diversified asset allocation portfolio.

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