Saturday, November 19, 2011

Fair value Accounting of own debt

Fair value accounting requires that assets and liabilities are valued not at historical cost but at current market prices. This extends to revaluation of one's own debt also. It has been revealed that 5 major banks in the U S namely the Citigroup, B of A ML, JP Morgan, Morgan Stanley and Goldman Sachs together have taken credit for more than 80% of their net profit totalling $16 bn for the quarter ended 30th Sep 2011 from this nefarious but permitted practice of revaluing one's own debt. Standard Chartered Bank desists from this practice. This practice is not unlawful though it is funny. In effect, a company or a bank in difficult straits says, "I am in difficulty. So those who have lent money to me may not recover the full amount from me as of now. This is reflected in the high spread on my Credit Default Swap. Accordingly, I revalue what I owe to others and cock a snook at my creditors. My profits are therefore bloated but this is strictly in terms of the concept of Fair Value Accounting." Ofcourse, the profits will get reversed when fortunes improve. This is a blatant anomaly that needs to be set right.

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