Sunday, July 06, 2008

Hating On Successful Journalists, And Being Confused About Accounting, Gretchen Morgenson Edition

This Sunday, Gretchen's still getting her head around credit default swaps. In this instance I'm torn between suspecting she's phoning this one in and wondering whether she needs to keep reading up on the subject. Certainly, starting a column with "Everyone knows..." is a frightening omen, not quite up there with inserting "obviously" into a horribly convoluted explanation, but certainly one of those crimes against journalism that even its lowlier denizens learn to avoid early on.

I'm acutely aware of the fact that some of my recent comments might be interpreted as hating on the powerful for hating's sake. For instance, I was all ready to go after this week's column for a few references to credit default swaps as "investments", followed by her description of CDS as a way to "bet" on a company defaulting. Thinking that since their origin lies in their use as a hedge against long positions in a company's debt, I thought this description, while accurate, was a little misleading. And then I thought about how Bill Ackman uses them, and realised that the description was entirely fair.

So, I finish off the article, but my god-Gari-you-have-to-stop-being-such-a-jealous-jackass sentiment entirely dissipates. Gretchen goes through two (internet pages) saying:

1) There's a lot of CDS out there
2) It's not well understood
3) There's a new accounting rule coming
4) This means more disclosure. This is good.

Gretchen's optimism comes from the fact that sellers of credit default swaps will have to account for these as if they were guarantees, rather than as financial instruments, and they'll then have to provide more information on size, counterparties, terms, and so on. Here's the summation:

For now, though, any increase in transparency where C.D.S.’s are concerned is a good thing. Of course, you can count on the usual caterwauling from executives and investors who like to blame accounting rules when the value of the assets they hold doesn’t go their way.

But for anyone interested in reality in financial statements, the new disclosure is a welcome step in the right direction. Let there be light.

Right, here's the standard preface: I'm. Not. An. Accountant.

But I can't work out whether the article's saying that the rule involves sellers of CDS changing from one interpretation to another (or from Statement 133 to Interpretation 45, to be exact, the reason for the rules having different classifications being unclear), or whether Interpretation 45 has also been tweaked as well. Since Morgenson calls it "unextraordinary" I'm tempted to assume it's the former.

Now, while I'm not an accountant, I've spent an unhealthy amount of time reading monoline samizdat, and I've noted how much they hate having to account for their credit default swap exposure as derivatives, because they say that these should be accounted for as guarantees. Why? Because they have to mark the value of the CDS exposures to market, which I'm guessing is the FASB 133 version, and the observable values of these contracts, which they have no desire to sell, are sitting in the toilet.

The monolines have a slightly good excuse for such complaints, since they're not likely to sell their contracts, and the holders of this protection can't accelerate them under ordinary circumstances (see earlier, ad nauseam for details of when they can. Gretchen's involved here too). They can say, with a certain amount of justification "this is what this contract is going to cost us to term; we're an insurance company, see, only not a massively well-run one, I'll grant you".

Is it fair to allow some writers of CDS to use this treatment? I can see the monolines that make it through the summer alive being fairly grateful for this. I'm sure a lot of banks are buyers rather than sellers of credit default protection, though if anyone has some proper figures for the relative volumes I'd love to know what they are.

But what it's likely to do is allow the writers to make predictions of how the instruments will perform to term, with the hope that the details of these exposures will provide enough detail to allow analysts to keep them honest. And for some writers of this protection (*cough* investment banks*cough*), market values may still be the best way to assess these exposures.

So the previous is my massively uneducated take on the subject. What's interesting here is that Morgenson's assumption is that the captains of finance won't like it. She even seems to reference young Andrew Ross Sorkin's pal diminutive library-namer Stephen Schwarzman, whose complaints have already been grist to my mill of envy. Could it be that what we're seeing instead is an end run?

I'm sure Jack Ciesielski, who's quoted by Morgenson and weighed in on Schwarzman, would be able to clear it up. But I'm too poor and shallow to pay for his insight.


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