As part of the aftermath of 2008's economic crisis and bailouts, the Fed is being forced to show that it will be different next time - a variant of the most dangerous words in investing - "it's different this time."
An article on Bloomberg News highlighted a remarkable comment. John Mack, CEO of Morgan Stanley (MS), stated, "We cannot control ourselves. You must step in and control the Street." In 2007, as markets were running wild and Mack's compensation exceeded $40 million, Mack was silent.
The first step of the 12-step program of Alcoholics Anonymous states, "we admitted we were powerless over alcohol - that our lives had become unmanageable." Apparently Mack now feels the same way about greed.
Later in the article, he states, “We have probably 15 to 20 Fed regulators in our building 24 hours a day. They test our models. They question everything we do. I’ve never been regulated like that before. It’s a different environment. Someone said to me, ‘What do you think of it?’ I love it.”
It is disconcerting that the guardian of our financial system (the Federal Reserve) has been forced to post 24 hour a day, on-duty guards. If this financial institution lacks the capability to police itself, how is it possible that the Fed will be able to do so?
Friday, November 20, 2009
Thursday, November 19, 2009
Aussie Approach is Standard & Poor (MHP)
Today's Sydney Morning Herald has reported that credit ratings issued by Standard & Poor's, the rating agency subsidiary of McGraw Hill (MHP), will not be available to retail investors after January 1. The rating agency has withdrawn its retail license application in response to a move by the Australian Securities and Investments Commission (ASIC) to withdraw protection from liability for ratings.
A move like ASIC's has been anticipated by many in the investment community. The question has been what the rating agency response would be. That is now answered. It would be peculiar if Moody's and Fitch did not follow Standard & Poor's. The issue is what the rating agency involvement will look like, if all three bow out of the "retail" market, but are available for the "wholesale" market.
Some have argued for greater accountability on the part of the rating agencies. Yet, it is not clear how such a model would work. Rating agencies provide opinions with limited information and an insignificant amount of compensation relative to the value of the securities rated. To be held to a downside risk with a nominal fee for an upside puts the rating agencies in the position of an insurance company with inadequate premiums. The appropriate response, then, was for Standard & Poor's to bow out.
A move like ASIC's has been anticipated by many in the investment community. The question has been what the rating agency response would be. That is now answered. It would be peculiar if Moody's and Fitch did not follow Standard & Poor's. The issue is what the rating agency involvement will look like, if all three bow out of the "retail" market, but are available for the "wholesale" market.
Some have argued for greater accountability on the part of the rating agencies. Yet, it is not clear how such a model would work. Rating agencies provide opinions with limited information and an insignificant amount of compensation relative to the value of the securities rated. To be held to a downside risk with a nominal fee for an upside puts the rating agencies in the position of an insurance company with inadequate premiums. The appropriate response, then, was for Standard & Poor's to bow out.
Wednesday, November 11, 2009
ConocoPhillips (COP): Goodwill Impairment
Like many of us, ConocoPhillips (COP) had a tumultuous 2008. In the 2008 COP annual report, the most dramatic change is a $25 billion decline in assets. Always starting with the balance sheet, I look to the stability of assets because earnings are so volatile. On inspection, COP's balance sheet showed that the decline occurred almost wholly in Goodwill.
Goodwill typically shows up on the balance sheet when a company has acquired another company. The price paid in excess of the tangible assets, such as property and plant, is carried in a category labeled "Goodwill."
Before 1970, this item simply stayed on the balance sheet. After 1970, accounting of Goodwill changed, leading to what Ian Cumming and Joseph Steinberg (co-chairs of Leucadia) described, "too much complexity robs simplicity and thus understanding." Warren Buffett also highlighted how the accounting of Goodwill diverges from economic reality in the 1983 BRK annual report.
FASB, seemingly believing that Goodwill should be eliminated, effectively calls for either its long term writeoff or its short term impairment. But all writeoffs are not alike; some are absurd.
When the stock market declined in the fourth quarter of 2008 (the time for impairment measures), the entirety of the powerful Exploration and Production segment was written off as impaired. To highlight the absurdity, this accounting impairment was identical to an event that occurred last year: Venezuela's expropriation of COP's assets. Is it possible that accounting cannot distinguish between stock market volaility and dictatorial asset appropriation?
Goodwill typically shows up on the balance sheet when a company has acquired another company. The price paid in excess of the tangible assets, such as property and plant, is carried in a category labeled "Goodwill."
Before 1970, this item simply stayed on the balance sheet. After 1970, accounting of Goodwill changed, leading to what Ian Cumming and Joseph Steinberg (co-chairs of Leucadia) described, "too much complexity robs simplicity and thus understanding." Warren Buffett also highlighted how the accounting of Goodwill diverges from economic reality in the 1983 BRK annual report.
FASB, seemingly believing that Goodwill should be eliminated, effectively calls for either its long term writeoff or its short term impairment. But all writeoffs are not alike; some are absurd.
When the stock market declined in the fourth quarter of 2008 (the time for impairment measures), the entirety of the powerful Exploration and Production segment was written off as impaired. To highlight the absurdity, this accounting impairment was identical to an event that occurred last year: Venezuela's expropriation of COP's assets. Is it possible that accounting cannot distinguish between stock market volaility and dictatorial asset appropriation?
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