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How Does $300 Billion Vanish?

May 17, 2008 05:30 AM
by Sushene S. Leitch
Several major financial institutions recently endured massive write-downs of assets: some observers claim the culprit is fair value accounting.

30-Second Summary

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How does $300 billion simply vanish? Many are asking this question after a steady flow of gargantuan write-downs by the world’s leading financial institutions.

Merrill Lynch, Citigroup, UBS and Deutsche Bank have stunned the finance world with recent massive write-downs. Jack Malvey, a research analyst at Lehman, tallied these global write-downs at $300 billion. The crisis ran so deep that J.P. Morgan was widely hailed because its write-downs were “only” $2 billion.

While a “write-down” does not represent an actual outflow of cash, it weakens a company’s financial position by reducing total assets. For a financial institution, this can be a death knell if it can no longer meet regulatory capital requirements, or if it loses the confidence of trading partners, as occurred with Bear Stearns.

Public companies have long been required to write down impaired assets on their balance sheet. However, the uptick in write-downs seems linked to the recently modified requirements of “fair value accounting,” instituted in the wake of the Enron scandal of 2001. With the market value of many financial assets declining, financial institutions operating under the 2007 guidelines are writing down the value of certain assets much further than they might have in years past. Observers now wonder if these requirements have benefited investors, or are instead exacerbating the current financial crisis.

Headline Links: Financial institutions report substantial write-downs

Background: What is fair value accounting?

Opinions & Analysis: Is fair value accounting worsening the financial crisis?

Reactions: “Tips” from the SEC

Reference: The fair value accounting rule

Related Topics: Did Enron start this ball rolling?

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