Confidence Tricks

One of the lesser publicised issues which conveniently was announced on the 2nd of April (the day of the recent G20 conference in London) was the announcement by the Financial Accounting Standards Board (FASB) in the US of the modification of the Mark to Market accounting rules. The change announced, and which was retro-active back to the 15th of March, meant that Financial companies and the troubled large banks in particular could now far more “liberally” value their toxic assets held on their balance sheets (and in time for the 2nd quarter results). The impact of course was immediate, with the ability to boost values and hence revalue profitability (fewer writedowns) bank profitability could be restored at the brush of a pen - or effectively the blind eye of the Accounting standards body.

Politically the announcement was strategic, coming on the day of the G20 conference, the stock markets responded favourably as profitability of the financial sector would immediately be boosted. The G20 leaders could reflect on a strong confidence boost (from the market rise) and all could go home happy. Or could they?

An accounting “trick” or basic dishonesty, as the author in this article highlights:

http://www.ft.com/cms/s/0/8ff883be-2f62-11de-a8f6-00144feabdc0.html

... really does nothing to solve the underlying problem.

The notion of “mark to market” is really quite simple. When valuing an asset on the company’s balance sheet that asset should be valued at its current market value. This is a concept that is also fundamental in Shariah. When Islamic companies (mudharaba, mufawada, anan, waji, etc) complete their regular end of period accounts, assets must be valued at their current market value. The capitalist problem is that many of the banks are effectively insolvent - being overly extended with worthless or close to worthless securities which are more akin to failed gambling chips than tangible assets. The “market” has given its verdict on these toxic assets and they are valued as “toxic” (junk) accordingly.

For governments to continue bailing out these banks by taking on board the toxic assets (TARP plan, nationalisations, guarantees and so on) is not only politically difficult but also very costly. And no one knows the full extent of this gamblers nightmare with 1,000 Trillion dollars of derivatives floating around out there.

To sidestep part of the problem by giving Banks the opt out to change their accounts (Wells Fargo, Goldman Sachs, JPMorgan and Citigroup have now all re-valued and posted stellar 2nd quarter results) doesn’t solve the problem. At some point in time the maturity of the “assets” will be reached and the losses must be taken on board. The real losers in the meantime are all the punters that are shareholders of these companies and in particular those that will buy the shares of these companies relying on corrupt accounting information. One can readily see the advantages of Islamic company law which maintains transparent accounting standards and requires investors to be more directly involved in ownership and operation of the company.

But confidence is everything. The capitalist politicians will seemingly do anything, including further corruptions of the market to try and build a way out of this disaster.