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Believe the write-downs, not firms' spin

Financial firms plagued by huge write-downs on their mortgage-related debt are trying to convince investors their fortunes aren't as desperate as they seem.

The corporate spin from companies like MBIA Inc., Citigroup Inc., and American International Group Inc. goes like this: The value of investments on their books may be plunging because of the credit crisis, but things won't necessarily stay bad forever. In due time, those holdings could rebound and turn into writeups. It's wishful thinking, and investors shouldn't let themselves be swayed by it. Accounting rules require assets to reflect current market values so that companies can't bury their risks.

"Some version of current value is much more relevant to investors than what something was paid for umpteen years ago," said Tom Selling, who writes the blog the Accounting Onion (, which tracks industry developments and accounting rules.

Under what's known as fair-value accounting, companies have to periodically update their estimate of what investments are worth based on how similar paper trades. That's more commonly known as "marking to market."

Such calculations are in no way a perfect science, something noted by Federal Reserve chairman Ben Bernanke during testimony to Congress last week. That's especially true in a stressed-out market, where many investments are illiquid and companies have to turn to often-volatile bond indexes to price their assets.

The difficulties of valuing assets is clear in the case of Credit Suisse, the investment firm that looked to have skirted the worst of the financial turmoil early in February. A week later, it reversed course, saying some of its traders had failed to keep up with the market downturn in valuing assets. That led to a surprise $2.85-billion write-down, resulting in a $1-billion drop in its quarterly profits.

Credit Suisse's losses added to eye-popping valuation declines all over the financial world —

$160-billion in write-downs since the start of last year, according to the Associated Press.

Companies are right in saying that today's valuation declines could become tomorrow's gains. But such views are built on a reversal in credit markets that isn't apparent right now.

In addition, talking about improvements in future performance fails to account for what happens if companies have to sell such investments at depressed prices in order to shore up capital levels. That would result in a sizable earnings charge.

Marking to market has its shortcomings, but investors should welcome the findings as a forced reality check.

Believe the write-downs, not firms' spin 03/06/08 [Last modified: Thursday, October 28, 2010 9:28am]
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