Does Fair Value Accounting + Credit Default Swaps = Global Deflation?

But today we wanted to return to the issue of fair value accounting and whether this last remnant of bubble-think is not driving us into the proverbial Thresher (SSN-593) scenario, straight down into the deepest trench of an economic correction that is well-beyond crush depth. Over the past several months, we have come to the conclusion that we must make a correction in the FVA rule. We see two issues:


First, FVA relies on efficient market theory, namely that short term price = value and that consequently income, assets and liabilities should be adjusted in real time to reflect same. (This is the same problem with CDS pricing, BTW, as we discussed in our last comment, ("To Stabilize Global Banks, First Tame Credit Default Swaps," Janury 21, 2009.) We think that the collapse of all of the other market efficiency based constructs, from structured assets to hedge funds, ends the discussion of derivative notions such as FVA.
Second, FVA fails to recognize the historical role of depositories, pensions and insurance companies as repositories for long-term value and consequently as havens from swings in short-term market pricing and economic trends. The whole point of capital adequacy regulation, with the notable exception of broker dealers, is to give such institutions the freedom to take the long view. FVA makes the long view impossible and basically turns what are supposed to be low-beta, low risk, highly solvent hold-to-maturity vehicles into mark-to-market liquidations every day via the CDS markets.

Just as you cannot buy bad assets from an insolvent bank at "fair value" without worsening the insolvency, likewise when you mark down assets you are reducing the ability of the entire financial system to support leverage. When you combine the zero effective collateral and margin operating in the CDS market with the quarterly idiocy of marking down performing securities and loans to satisfy the advocates of FVA, it would be difficult to imagine the enemies of the United States constructing a more perfect weapon to bring about our collective demise.

My thoughts are these..

A property that returns rent is valued at what some one will pay for it, buy the market. NO matter how much rent is return, the valuation is based on risk. I understand CDS return a premium (rent) so why should they not be valued at market values, no matter what the premium (rent) is. Also the accounting used on the way up from 2003 to 2007 was just fine then ( bonuses paid etc), so whats so bad on the way down. Also how can some one value a CDS if it is very complicated and not transparent, if you have a property with a complicated lease agreement your valuation is very much effected. Once again the valuation and associated risk are equal. It seams to me the Accountants are the HEROS out there, the whistle blowers. Just how many SP500 banks balance sheets are 100% transparent then ? ( add GE to this list). I say get a real market (exchange) for the CDS for better or worse valuation, dont blame the accountants.

So why should the CDS valuation rules be changed, they maybe as it becomes political. But remember that CASH bonus where paid out on these PAPER valuations going up in the good times, so to help stop WALL STREET and now main street from going into massive deflation we need to change they playing field. So who is correct ??

Valuation is based on risk for return, and if the risk is high as transparency is low (CDS whats in it) and complications (CDS what are they real terms of agreement) are high then valuation will be low, just like a rental property (no matter what the cash flow is) !!!