It turns out that because of the different types of financial instruments market players created, that the U.S. Financial Accounting Standards Board (FASB) decided to create three separate levels of accounting to separate and grade the good financial instruments from financial crap that was produced over the past 10 years.
Level I is for basic financial instruments that you can buy and sell. Everyone agrees who owns it, and agree on what it’s worth. It’s like your car. You own it. Everyone has an idea of what it’s worth because it's pretty much a standard automobile. And if you want a second opinion, you can go to Kelly’s Blue Book.
Level II is for financial products whose value are less known because they’re not traded as often. But the products are part of real markets that are known and (mostly) respected by financial players. It’s like the car collector who has a rare car whose value is indeterminable, but everyone knows they’re worth something. If you want a second opinion, you go to an expert.
Finally, Level III is for financial products that are not worth what market players paid. They're toxic and worth crap in the market. Everyone knows it, but the owners are hoping that it will be worth something one day. It’s like owning a Pinto. You may have purchased it for a good chunk of change but, ultimately, it’s worth crap - and everyone knows it. Still, there’s hope that in the future (like in the next Ice Age) it might be worth something (as a form of shelter).
But, today, it’s worth crap. Especially since you know that it could blow up in your face at any time.
Pretty simple, huh? OK, on to the next point.
Apparently, the number of financial - and very toxic - crap at Level III accounts for about 15% of all the financial instruments out there (up from 9% last year). That's alot of Pintos. But it's still only 15%, so what’s the problem, right? This is the wrong question.
We should be asking How much is this 15% is worth?
It turns out that while all of these financial instruments (in Level III) have a combined book value of about $610 billion their real market value has plummeted. No one knows how low the value of these instruments are because no one wants to purchase them (especially since home prices and foreclosures are moving in opposite directions). It’s like you bought a “classic” Pinto for $10,000 only to find on delivery that “classic” meant you purchased a used beat up Pinto that’s really worth $250.00 (even with the aerodynamic luggage rack).
Why is this important? Because, according to one account, $610 billion in Level III crap is “many times bigger than the market cap of the banks.” Put another way, all the crap that’s on the books at Level III has the potential to bust these banks in the future because their value is more than the banks are worth.
This explains why market players want to change the accounting rules. They want to revalue the toxic financial instruments according to non-market prices. In Finance Speak they want to abolish "mark-to-market" accounting methods. In our car market, one could say they want '65 Mustang value, for their piece of crap Pinto.
The accountants who follow and understand this stuff have another take on this. They say what the financial sector is really asking for is that “mark-to-make-believe” accounting standards be applied to their industry.
Whatever they call it, Wall Street's financiers want to be reimbursed by the federal government full book value for the toxic financial instruments that they've created. They want another subsidy. Mark-to-Make-Believe will help them do this.
As Yogi Bera would say, "It’s déjà vu all over again."
- Mark
P.S.: For a somewhat humorous take on the financial sector's blood-sucking ways, check this out.
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