Suppose a major financial innovation fails and causes enormous ‘creative’ destruction.

What do you do?

Such a creative innovation was the so-called CDS, credit default swaps. Huge losses were caused to bank’s balance sheets when the bonds and other investments insured by CDS’s went into default.

The losses appeared at once on the balance sheets of banks, because banks are required by accounting laws to “mark to market”. That is – to record a loss when the market value of an asset declines in its market price. 
These laws are widely applied in the United States, in Europe, and in so-called International Accounting Standards.

Bankers have complained about these rules, saying they make their balance sheets look worse than they really are, because when markets are not working, some assets are valued at zero, when (if given time) they are worth far more on a long-term basis. 

The international accounting regulatory body IASB (International Accounting Standards Board) that sets accounting rules for almost 100 countries made (almost unnoticed) a few changes last week, according to the Wall St. Journal (Monday Oct. 20, p. 19,  European edition). These changes may allow banks to reclassify assets like loans and receivables. They could broaden the change to include derivatives, which includes CDS’s. 

So – let us try to get this picture straight.

Investor trust is destroyed by the foggy murky ‘financial engineering’ that created risky assets few understood, hid them behind complexity, and distorted them with bond ratings of AAA.  

And now, investor trust is going to be restored. How? By allowing banks to better hide their toxic assets rather than disclose them fully and transparently.

Good thinking, IASB! Why not allow retrospective changes in financial reporting, that simply ignore the trillions of dollars in losses and in toxic assets and show that, well, the whole thing never happened! That will surely make everyone feel a lot better, right?

Hopefully screams of protests from scalped investors will set the IASB straight. Stop this before it goes any further. We need more transparency, not less. If a bank has lost money, we want to know about it. The job of financial reporting is to reveal the truth, not to hide it!

Advertisements