A Simple Alternative to Mark to Market Accounting?
I haven't posted at all on the brouhaha about mark-to-market accounting of derivatives and whether it was a contributor to the recent financial mess. If I had to summarize the issue, I would describe it thus: Investors want something more trustworthy than just management estimates of the value of complex securities -- so they would like an outside market-based reference point -- but the very complexity that makes these contracts hard to value as an outsider also tends to make their markets illiquid and volatile, making it difficult to get a good market value.
Tom Selling addresses the problem of accounting for the value of credit default swaps here. He makes what seems to me to be a common sense suggestion:
Requiring the asset and liability sides of derivatives to be separately
measured and reported seems like an amazingly simple fix that could
simplify regulation of the financial and insurance industries, reduce
the need for the disclosures in financial statements written so as to
discourage one from reading them, and help investors more easily assess
risk.
This certainly seems reasonable to me. When one buys a revenue producing asset with debt financing, the two are listed separately as an asset and a liability, rather than as one "net" asset, even though they may be inextricably linked (say if the asset is collateral for the loan and the loan has high pre-payment penalties). Any thoughts? Does this make sense, or is it naive?
