Our Brave New World and a change in my understanding of mark to market accounting

When I went to the AOL site this morning to get my email I found a new feature that's like the home price estimator at zillow.com. Having nothing better to do, because corporate recruiters are still among the unneeded and undervalued if not toxic assets of this economy, I clicked on it.

No surprise in the valuation. Our home is now estimated at $330,000, down about 30% from the $470,000 that zillow was estimating it at the very peak of the real estate boom valuations in July of 2007. What was really interesting is that AOL Real Estate has a much better satellite or aerial photo of our home and lot than the one I last saw on zillow a few months ago, and I can almost precisely date that photo.

That photo, a very clear one, shows the redbuds and the crabapples in bloom and my garden as a rectangle. It also shows the big hybrid poplar nearest the house, a tree we had removed in 2006, still in place. Finally, it shows the white plastic recliner out on the lawn in the sun. So it has to have been taken in the late Spring, about mid May, of 2005, almost surely on a Saturday or Sunday since I was working pretty intensively on the weekdays during that period. We all still thought real estate values would rise forever and the biggest business problem at my contract employer was the difficulty of continuing to hire enough new people to expand fast enough to ensure that the other commercial mortgage companies would never catch up in our specialized market niche.

First off, what a brave new technological world we live in. A couple of clicks and I'm looking at an image of our house and lot from above, an image clear enough so I would probably be able make a good guess at the tee shirt I was wearing if I had been in the recliner when it was taken. I think that image is from a stitched together pastiche of aerial photos rather than from a satellite photo. The implication is that the entire country, if not the world, is now imaged at a resolution of about a foot and searchable. Somewhere, some biology graduate student who knows that polar bears do not shit in the woods is counting the brown blobs on the snow and writing a paper on how many craps a polar bear took last week and how far apart they are. Somewhere else, someone with different interests is occasionally stumbling across a picture of a California or Florida swimming pool owner who thought he or she could take a dip in the nude in total privacy.

But enough of that line of thought. I have serious quibbles with the rather simplistic calculation assumptions that zillow and now AOL make about home values. Our home, for instance, appears to be valued almost soley on the basis of its square footage and bedroom and bathroom count. The system they both use assigns little or no value to the land that our home sits on, a much larger and infinitely more private lot than those of the houses presented as comparables. This is only natural because it's no doubt impossible, at least now, to put a value on purely esthetic factors, But the AOL valuation also misses the potential for subdivision of our five acre home lot.

Which brings me to my other point. The other day I asserted that the value of something is simply what someone is willing to pay for the thing. On Commentary Magazine's Contentions blog yesterday I came across a comment that made me recognize a slight wrinkle that I hadn't considered which is perfectly demonstrated by my reaction to AOL's valuation of our house. We, the owners, have a better understanding of both intangible and tangible factors that go into the value of our house. We know that the privacy has great value to us, if not to others in the general marketplace; and we also know that the lot is subdividable.

So there is no way we would trade our house and its lot for one of the comparable houses worth $370,000. As the commenter on Contentions correctly pointed out, accounting for value has to take into consideration the price at which the owner of an asset would be willing to sell it as well as the price at which some other party would be willing to buy it. And for thinly traded assets that bid versus asked spread can be pretty wide. For our home, for instance, the bid versus asked spread is more than the current bid price, at least as simplistically arrived at by zillow and AOL. We might sell if someone showed up tomorrow with a check for double the valuation on AOL; but I'm not sure. Even putting aside the pretty tangible value of subdivision we might not sell. Linda and I both like the pond and the privacy a lot.

So we're back to this question of mark to market accounting. The banks unwilling to sell those so called toxic assets at current bid prices presumably understand those assets somewhat better than the potential buyers do. Hence, the toxic assets are worth more than the bid price as I asserted the other day; but how much more? The mere fact that my best answer to that question is "Who knows?" says that this question of mark to market accounting is more complex than I asserted the other day.

Do bankers know the value of the assets in their vaults? Do bears shit in the woods? Do Californians and Floridians swim in the nude?

Not always.

And - in somewhat related news, here's a 3 minute speech by a member of the European Union parliament that's fantastic. We should offer this guy citizenship and elect him to our congress. It would be refreshing to have one politician down in Washington who makes sense.

"You cannot borrow yourself out of debt."

http://www.youtube.com/watch?v=94lW6Y4tBXs

Insisting that something is a fresh rose does not make it smell sweet

Last Saturday Sam brought up the question of "mark to market" accounting. Most people have completely avoided learning about mark to market accounting because it seems like one of those complicated subjects that are best left to the boring accountants who wear green eyeshades and garters on their sleeves.

But mark to market accounting is actually very simple. Anybody can understand it. Let's take an example.

If you are wise you have probably been saving some money toward retirement. Over the years that money has been slowly building up and you've been investing it, perhaps in stock market mutual funds. For years and years you were generally pleased with the statements you got from the mutual fund company every three months. Last September you looked at your statement and were pleased to see that the $5,000 you had invested over the years had grown into $10,000 or so in the account. Very pleasing!

But then you got a shock when you looked at your statement in December and found that your account had suddenly shrunk as the stock market went down, and the value was back down to about $5,000. Recognizing that the account is worth what its worth is mark to market accounting. Whether you like it or not the value of your investments is what it is. If you're like me you may be pretty optimistic that the value of the account will go back up again over time; but there's absolutely no sense in trying to pretend the account is still worth $10,000. One of the oldest and simplest rules of life is that an economic asset is worth what someone is willing to pay for it, no more and no less.

Some people don't like that simple rule, so they lie to themselves. They tell themselves that their stock market account is still worth $10,000 even though other people in the market are only willing to pay $5,000 for the stocks in the account. Or they tell themselves that their house is worth $200,000 because their neighbor on the right hand side sold his house for $200,000 a couple of years ago, even though they just talked to their neighbor on the left hand side who has had his house listed on the market for six months and the best offer he's gotten so far is $160,000.

Pretending that your stock market account is still worth $10,000 or your house is still worth $200,000 under such conditions is fantasy accounting. It may feel good; but it makes no sense. It's nothing but lying to yourself.

Timothy Geithner and many of the other big heads down in Washington want to let your neighborhood bank pretend that the stocks and bonds and mortgage derivatives in its vault are still worth what they were worth in September. They want to let the bank lie to you and to its owners and claim that those stocks and bonds and mortgage derivatives are worth what they paid for them. Trust me, those stocks and bonds and derivatives in the bank vault are worth what the bank can sell them for today, just like your retirement fund stocks or your house are worth what you can sell them for today.

The big heads claim that the banks need to pretend because there is "no market" for the mortgage derivatives that many stupid bankers bought and put into their vaults. But that too is a pernicious lie. I can assure you that there is a market for mortgage derivatives because I myself am ready to go to any local bank and inspect the paperwork and make an offer for some of their securities.

I'll go further and guarantee that I'm willing to buy a random selection of the mortgage derivatives in the vault of Citibank or Wells Fargo Bank or even AIG even without the chance to inspect them with no more surety than a notarized letter signed by the person who selects the derivatives and the Chairman, Chief Financial Officer and General Counsel assuring me that the selection is truly random, and I don't know very much about derivatives at all.

Heck, I'm even willing to name a price. I'll pay a hundred bucks for ten billion of face value of the mortgage derivatives in the vaults of any of the banks whose stock is listed on the NYSE, sight unseen, under those simple terms - a random selection. So all you bankers with toxic assets; send me the letter and the random selection of derivatives and I'll send you the hundred bucks. If you don't feel comfortable trusting me for the hundred bucks, send me the notarized letter alone and I'll trust you. Even though I know you have a history of lying I'll send you the hundred bucks even before you send the random selection of derivatives.

Give me a few days to put together a team of a two or three folks who know more about mortgage derivatives than me and I'm very confident that we will be willing to pay more, maybe even a thousand or ten thousand bucks per billion of face value, for derivatives if we can visit the vault of Citibank or Wells Fargo or even AIG and pick the ones we're buying. So don't go on telling me there is no market for mortgage derivatives.

I don't expect to be offered the chance to buy mortgage derivatives at those kinds of prices, of course, because there are lots and lots of other people in the world with much more money and much more knowledge of mortgage derivatives than me. And lots and lots of those people already have staffs of people who can help them evaluate the derivatives on very short notice.

There is a market for the so called "toxic assets" of the banks; but the executives of those banks and the big heads down in Washington don't want to recognize that the prices that market is willing to pay is much less than what they are claiming on their fancy accounting statements.

http://www.forbes.com/2009/03/16/mark-to-market-accounting-business-wall-street-fasb-157.html