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Up Is Down, Black Is White And Credit Crash Is Profit

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Couldn't believe this:

http://money.cnn.com/news/newsfeeds/articl...28_FORTUNE5.htm

Seems that under new US accounting rules, a bank that loses its credit worthiness - can interpret the loss of credit worthiness as reducing the value of its own debt. So, as their credit worthiness drops, the market value expectation of the value of their debt drops, and they are deemed to owe less. If you owe less, you've made a gain.

It is just fantastic, we all misunderstood Northern Rock, all the time they were just ensuring bumper profits and bonuses by creating an artificial bank run. No on expects them to pay out on their bonds, so they owe less, and make gains. Sadly the Treasury misunderstood, interfered and ruined the scheme. I reckon they should sue Alistair Darling for their lost bonuses.

Good news for BTL investors too... incorporate in Delaware, wait for falling prices on nasty flats, apply Financial Statement 159, Bob's your uncle, you're minting it again.

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Couldn't believe this:

http://money.cnn.com/news/newsfeeds/articl...28_FORTUNE5.htm

Seems that under new US accounting rules, a bank that loses its credit worthiness - can interpret the loss of credit worthiness as reducing the value of its own debt. So, as their credit worthiness drops, the market value expectation of the value of their debt drops, and they are deemed to owe less. If you owe less, you've made a gain.

It is just fantastic, we all misunderstood Northern Rock, all the time they were just ensuring bumper profits and bonuses by creating an artificial bank run. No on expects them to pay out on their bonds, so they owe less, and make gains. Sadly the Treasury misunderstood, interfered and ruined the scheme. I reckon they should sue Alistair Darling for their lost bonuses.

Good news for BTL investors too... incorporate in Delaware, wait for falling prices on nasty flats, apply Financial Statement 159, Bob's your uncle, you're minting it again.

Same story in the New York Post.

http://www.nypost.com/seven/09202007/busin...ing_a_bulle.htm

Amazed no one in the UK has picked it up.

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Couldn't believe this:

http://money.cnn.com/news/newsfeeds/articl...28_FORTUNE5.htm

Seems that under new US accounting rules, a bank that loses its credit worthiness - can interpret the loss of credit worthiness as reducing the value of its own debt. So, as their credit worthiness drops, the market value expectation of the value of their debt drops, and they are deemed to owe less. If you owe less, you've made a gain.

It is just fantastic, we all misunderstood Northern Rock, all the time they were just ensuring bumper profits and bonuses by creating an artificial bank run. No on expects them to pay out on their bonds, so they owe less, and make gains. Sadly the Treasury misunderstood, interfered and ruined the scheme. I reckon they should sue Alistair Darling for their lost bonuses.

Good news for BTL investors too... incorporate in Delaware, wait for falling prices on nasty flats, apply Financial Statement 159, Bob's your uncle, you're minting it again.

This is old news (think Marconi) in that under IFRS (international accounting standards that apply to UK listed companies) the same treatment applies, and there is some logic to it.

If a firm issues listed debt at par, say GBP100, then it will obviously record a liability of GBP100. However, as with all types of asset the market price will vary and in the case of debt the main factors will be the credit risk of the issuer plus interest rate forcasts.

If the debt trades at below par, for any reason then the issuer has in fact made a paper gain as it could go in to the market and repurchase the debt. Hence if the GBP100 debt was trading at GBP95 and was bought back by the issuer at this price the issuer has made GBP5 profit i.e. it raised GBP100 and extinguished the debt by paying only GBP95.

Obviously there are downsides to this treatment in that debt will usually only be downgraded when a company is in trouble but it should be remembered that the price of debt will fall if the interest rate is fixed and rates rise.

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This is old news (think Marconi) in that under IFRS (international accounting standards that apply to UK listed companies) the same treatment applies, and there is some logic to it.

If a firm issues listed debt at par, say GBP100, then it will obviously record a liability of GBP100. However, as with all types of asset the market price will vary and in the case of debt the main factors will be the credit risk of the issuer plus interest rate forcasts.

If the debt trades at below par, for any reason then the issuer has in fact made a paper gain as it could go in to the market and repurchase the debt. Hence if the GBP100 debt was trading at GBP95 and was bought back by the issuer at this price the issuer has made GBP5 profit i.e. it raised GBP100 and extinguished the debt by paying only GBP95.

Obviously there are downsides to this treatment in that debt will usually only be downgraded when a company is in trouble but it should be remembered that the price of debt will fall if the interest rate is fixed and rates rise.

Interesting. Raises three questions.

1) Do most UK companies use this approach?

2) Does the same argument work in reverse - ie if the price of the debt rises - for example if rates fall (as they will if the BoE responds to the current liquidity crisis by cutting rates)? Maybe most companies issue floating rate paper?

3) Is it common in the banking sector? If so, did Northern Crock do this?

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Amazing stuff. Doesn't it mean though that if their financial position improves, they then have to book massive losses?

I'm surprised more people don't find this story outrageous.

The justification for booking the reduced bond price as profit is that they owe less. In some ways this could be justified, say they issue a bond that costs $1, but can buy it back before it becomes due for only $0.80 then they effectively make a $0.20 profit. They wouldn't have to book losses in that scenario.

However, the argument, despite being legal in accounting terms, is largely nonsense. The $0.80 price is what a marginal holder (ie one prepared to sell at the moment) would accept in cash for the bond. It doesn't however follow that all the bond holders would be prepared to settle for only $0.80 on the dollar. Many investors would have offset the default risk on the bonds in some other way (via some sort of credit default instrument), and so they will want the full $1.00 because they've already offset the risk. Another point is that the reduction in price depends on the issuer having a probability of default, as it gets closer to the redemption date, the risk reduces and so the price will go back up! Furthermore, the current price ($0.80) in this example is based on the bond holder being prepared to sell at that price, the reason for that might be that they themselves are desperate for cash, in which case, the less desperate bondholders wouldn't accept so low a price.

Overall, the whole thing is crazy. I'm reminded of the comments made by Jon Moulton at the recent select committee enquiry where he said that the financial world was now so complicated that even he didn't understand it all.

We are supposed to have confidence in the worldwide banking system, and then we see stories like this one. Given the underlying craziness of the system I am staggered that there is so little reporting of this story. I think, maybe, it is because very few people on the Clapham omnibus understand profit and loss, and so this type of subterfuge is just too complicated for most people to understand, and so the banks get away with it!

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I'm surprised more people don't find this story outrageous.

The justification for booking the reduced bond price as profit is that they owe less. In some ways this could be justified, say they issue a bond that costs $1, but can buy it back before it becomes due for only $0.80 then they effectively make a $0.20 profit. They wouldn't have to book losses in that scenario.

However, the argument, despite being legal in accounting terms, is largely nonsense. The $0.80 price is what a marginal holder (ie one prepared to sell at the moment) would accept in cash for the bond. It doesn't however follow that all the bond holders would be prepared to settle for only $0.80 on the dollar. Many investors would have offset the default risk on the bonds in some other way (via some sort of credit default instrument), and so they will want the full $1.00 because they've already offset the risk. Another point is that the reduction in price depends on the issuer having a probability of default, as it gets closer to the redemption date, the risk reduces and so the price will go back up! Furthermore, the current price ($0.80) in this example is based on the bond holder being prepared to sell at that price, the reason for that might be that they themselves are desperate for cash, in which case, the less desperate bondholders wouldn't accept so low a price.

Overall, the whole thing is crazy. I'm reminded of the comments made by Jon Moulton at the recent select committee enquiry where he said that the financial world was now so complicated that even he didn't understand it all.

We are supposed to have confidence in the worldwide banking system, and then we see stories like this one. Given the underlying craziness of the system I am staggered that there is so little reporting of this story. I think, maybe, it is because very few people on the Clapham omnibus understand profit and loss, and so this type of subterfuge is just too complicated for most people to understand, and so the banks get away with it!

If I'm reading this correctly Freddie Mac is at it too!

http://www.earthtimes.org/articles/show/fr...ts,392638.shtml

Improved results also reflect lower interest-rate related mark-to-market

losses as a result of the company's adoption of SFAS No. 159, "The Fair Value

Option for Financial Assets and Financial Liabilities - Including an amendment

of FASB Statement No. 115" (SFAS 159). Effective January 1, 2008, the company

elected the fair value option for certain available-for-sale mortgage-related

securities and its foreign-currency denominated debt. Upon adoption of SFAS

159, the company recognized a $1.0 billion after-tax increase to its beginning

retained earnings at January 1, 2008. See the Appendix for more detail on the

adoption of SFAS 157 and SFAS 159.

My reading is that the extra $1bn helped bring them to a loss of only $151m, much easier to explain away than $1,151m. Can anyone correct me if I am misinterpreting this?

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Surely the companies who are using these new accounting practices are cutting their own throats long-term for the benefit of of short-term appearances? Savvy investors who actually look at the published accounts will note the use of the technique and steer well clear...

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Surely the companies who are using these new accounting practices are cutting their own throats long-term for the benefit of of short-term appearances? Savvy investors who actually look at the published accounts will note the use of the technique and steer well clear...

Oh come on.

It's just numbers on a PC screen.

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I was reading one of the Darwin awards books the other day. A guy wanted to get a piece of a rare tree. Not being stupid he didn't actualy saw the branch he was sitting on- he stood on the branch below to do the sawing. The branch came off and took him out. :P

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