Power And Dollar

Bailing Out Van Gogh Traders?

The senate has passed Bailout bill, an important bill by itself and even more so during an election season.  Simultaneously, Americans are debating about the next President as well as the centennial financial crisis.  The debate will continue: about what sweeteners ought to be in and what to be tossed out (mainly the idea of buying toxic assets from the banks), even after this implementation.  However, this bailout probably provides an excellent stage for a third debate: what is fair market value?


Part of this mess has something to do with the accounting rule about the value of an asset.  Currently, the valuation of an asset goes by the rule of “mark-to-market”.  Politicians (French Sarkozy for now) is ready to bend the “mark to market” rule .  However, plenty of accountants can explain to you why “mark to market” is important.  


No one can argue against accountant accounting, although plenty of people can win arguments against lawyers about laws.  Accountants will tell you that it is about liquidity in the market, it is about protecting shareholders, etc.  Ask yourself this: can you put all your money into a box that you may not be able to open and retrieve your money?  Accountants are saying you should put the money into something you can always retrieve.  Mark to market makes the box transparent to you.  Even though you are not retrieving the money at this moment, you can still see what you got in the box.  Liquidity gives you transparency.  However, you still have to sell the asset in order to see the value.  With mark to market, you can see the money, based on the current market conditions.  


It comes back to the market design.  Financial institutions put the money in market(s) where the products are thinly traded (not much liquidity).  Thus, if everything is mark to market during the good times, everyone and everything is fine since every asset value is growing.  However, once it falls, liquidity vanishes quickly.  Who is ideal to take the role of market design? Regulating bodies.  Regulating body does not have to be the government.  American Bar Association is a self regulating body.  Accountants used to be a self regulating body.  However, in centennial financial crisis, there was no regulating body for these asset backed commercial papers.  



Let me give an example of a market that has a similar liquidity as the situation we are in: fine arts.  


When the economy is in boom, paintings (or whatever else Sotheby auctions) sell well, both in quantity and in price.  However, once the economy goes down, both quantity and price go down.  When quantity goes down, there is no market and thus no market value for anything you hold.  


In a sense, all these financial institutions were trying to make money out of trading Van Gogh.  That makes this bail out like a Van Gogh traders bail out.


October 2, 2008 - Posted by | Barack Obama, Current Events, Democrats, economics, election, Election 2008, John McCain, mccain, obama, politics, Regulation, Republican, wordpress-political-blogs

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