DeLeveraging & Valuation

My partner and I recently discussed this post, and the Wall Street Journal editorial by Holman Jenkins which motivated it.

After some initial back-and-forth comments during which it appeared that he and I disagreed, my partner's remarks focused on the duality of valuation in the recent case of various financial instruments whose values have plunged due to forced sales from margin calls.

How does one consider securities sold at incredibly low prices due to financing decisions? When the valuation is driven by temporary current market forces, not long term value, is 'mark to market' really valid? Specifically when the cause of the valuation change is a global deleveraging brought on by a change in bank collateral requirements of many institutional investors who have heretofore employed leverage in their strategies?


What is 'value' in such a case? As my partner noted, there is a duality, because perspective really determines it. The value is driven more by some bank's tougher margin requirements than the intrinsic value of the instrument, per se.


Is it reasonable for the balance sheet of a firm to reflect instantaneous market forces valuing its assets?


My partner initially decried anything but 'mark to market,' but then relented, somewhat, when I pointed out that all 'mark to market' really does is try to make an historically-based balance sheet become market-priced.


We have 'par' values on accounting books, and then each person's analysis to translate historically-costed assets into 'market values.'


At least one thing that is happening is that investors with cash are gorging themselves on improperly under-valued long term assets in a temporary meltdown.


For the purposes of accounting rules, we see real, tangible functioning financial service firms go out of business due to 'market valuation' rules simultaneous with bank lending contraction by way of margin rule changes.


As my partner, trained as an accountant, noted, using GAAP is simply following one set of rules, rather than another. But they are not etched in stone. I had a graduate accounting course professor who delighted in demonstrating that, by perfectly acceptable use of accounting assumptions and GAAP principles, he could not only vary earnings per share more than a marketing or production function could, but that he could accurately forecast that EPS for December 31 of the year on the day after New Year's of that same year.


Is the forcing a mostly historically-priced balance sheet to suddenly need to approximate real-time market values of use beyond the reasonable intent of financial accounting? Isn't it actually a sort of cash-like, dumbing down of GAAP principles, so that any idiot viewing the company's balance sheet and asset 'values' knows they are current?


But we have analysts and counterparties to also perform these tasks, with a more adversarial bent. Providing a 'market value' approximation for a firm is, as my partner and I agreed, a matter of perspective. Thus, a single, 'market value'-based of assets of a firm is probably an oversimplification anyway.