September 28, 2008

The Perils of Fair Value Accounting

Filed under: Business,Economics — Bottom's Up @ 12:40 pm
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Any new student of accounting gets bewildered by the historical cost concept. The premise of this being that long term assets should be reported on the books at the value that they were bought at (apart from depreciation etc). The most commonly used example is that of land – land is usually reported on the books in the US system at the cost at which it was bought at. Land being such, usually appreciates and thus in the course of time, the value on the books ends up being being below the market value and firms are forced to report less assets than they have.

However, in recent years, firms have been allowed to report financial assets at market values instead of historical costs. For sometime this was considered a good idea, but in recent months has become the cause of much debate thanks to the credit crisis. The Economist last week had a great article on problems related to the same. An interesting point that the Economist brought out and which this writer was not aware of was

Today the treatment of a financial asset is determined by the intention of the company. If it is to be traded actively, its market value must be used. If it is only “available for sale” it is marked to market on the balance sheet, but losses are not recognised in the income statement. If it is to be “held to maturity”, or is a traditional loan, it can be carried at cost, subject to impairment. This is a dog’s breakfast. Different banks can hold the same asset at different values.

Noe this is indeed terrible. A big part of the problem recently has been one of the adverse selection problem. The only way around adverse selection problems is to reduce the level of assymetric information when it comes to dodgy products. Of course, this is easier said than done.

UPDATE: Justin Fox of Time has an interesting update on what’s happening on this front currently.


August 20, 2008

When Purple Words Cry Out In One Voice

Filed under: Foreign Affairs,Media — Bottom's Up @ 12:18 am
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Being someone who loves reading the news and the countless views that come with it, I can safey describe myself as someone who is in love with the business of dissemination of news. And while it may have its warts and Media Bias is but a fact of life, the simple way to get around it is to read the publications hated by the liberals as being too conservative and then those by the conservatives as being too liberal and one stops seeing the blacks and whites. Of course, gray is usually less sexy but more interesting than the visuals the color may bring to mind on first thought. Which brings me to my current kvetching – the times when one has to look beyond the liberal and conservative publications and actually dig for the true story. Two very recent instances come to mind.

Take for example the failure of the most recent offering of Doha round of trade talks. Most of the western media talks about how India and China torpedoed the talks. That the failure was due to the lack of agreement on something not as critical as safeguards under the conditions of excessive imports in the agriculture sector. However, little was said about why India’s minister Kamal Nath was treated as a hero on returning home after the talks. The usual suspect on offer was protectionsim. Sure, India wanted to protect its farmers. It is an election year in India too, farmers are committing suicide and inflation is sky high. However, little was said about the chief complaint of the Indian farmers and thus the politicians. This was the subsidies offered by the US to its farmers. Business Week cited this only as an after thought. The Economist, one of my favorite publications and usually a lot more astute, did not do much better. Its only today that I saw something in the FT which touched upon the heart of the matter as far as the Doha Round was concerned.

The US role in the failed Doha trade talks illustrates the collapse of American leadership. Here, the US has been the central spoiler, refusing to cut its trade-distorting subsidies significantly even though they are universally recognised as intolerable. Its latest offer was to cap them at $14.5bn (€9.84bn, £7.76bn) but that well exceeded current payouts, estimated at $9bn. With only 2m farmers in the country, the US still attacked India for asking for an enhanced “special safeguard mechanism” to be used in case of an import surge, when India has far smaller, often subsistence, farms and nearly two-thirds of its population in rural employment.

Yes, it is true that a lot of the current mess in the Indian agriculture sector is thanks to little infrastructure for modern agriculture (a majority of it is still rain fed), poor availability of credit, an inefficient and corrupt public distribution system among others. Still, the anger over  subsidies is a thorny political issue and one that any Indian politician would not agree to unless he has something to show for it and thus India’s adamance on sticking to its guns in the recent talks. Of course if one went purely by western media reports, one would think it was very simple issue of India and to an extent China trying to bully the rest into agreeing to some unreasonable demands. And then there is Mr Barack Obama, the supposed messenger of change, who continues to support the farm bill and inadvertently big agri.

The other instance where the liberal and conservative media both have failed to cover the issue properly is that of the current mess that is Georgia thanks to Russia. No doubt that Russia has done something which is wrong. To further its global ambitions, it has made the people of Georgia suffer. Whatever may be its actions, this is not something to be justified. And yes, we have heard a lot about this and about what Russia’s intentions are. However, how much have we heard in the western media of the failure of American and European diplomacy. It does not take a lot to figure out that Russia was a wounded giant. And that if angered, there is little anyone would be able to do about its actions, as one sees now. And that Putin and Co. have expressed the desire to take Russia to its former ‘glorious’ heights. However, while I wont claim to have read everything that has been written about the issue, what I have seen is mostly a lot of flak for Russia but few words about the failure of Western Diplomacy – a failure which is quite big and reeks of an establishment out of touch with realities.

Where any sane person group of diplomats would have tried to make Russia a part of their group, give them some harmless importance instead of alienation and thus temper their hurt and pride. And before one starts crying foul on appeasement, one needs to remember that giving someone respect deservedly (they are after all a powerful nation and also economically relevant) is not the same as appeasement. Instead our geniuses, deluded by some cold war syndrome,  decide to take the fight to Russia – encircle it through NATO at its borders, arm its neighbours and other such faux pas. At the same time, they continue to  treat Russia as an outsider. The results are for all to see – the western diplomats have come out looking helpless and full of empty words. G. W. Bush has been reminded that he cannot bully Russia and the big losers have been the people of Georgia. Nor has it helped make the world any safer. The same policy is being suggested again and again when it comes to China. One just has to listen to Mr Foriegn Policy – John McCain – who in a supposedly important policy speech said as much, that Russia and China need to be isolated. Hopefully economics in a globalized world will not allow another occurance of bipolarization in the world. Multi polarization is the worlds safest bet. But instead the media has said little about this. After all maybe the media needs to be patriotic and not come out looking like its justifying Russia’s actions.

August 9, 2008

Some More on Pigovian Taxation of Oil

Filed under: Economics,Governance,Politics — Bottom's Up @ 2:15 am

Business week has a nice article, which after everything is said and done, ends up advocating for some sort of Pigovian Taxation on Oil.  Something a lot of analysis against taxation of oil misses is the simple fact that at the moment there is no economic cost associated with polluting the air (through the use of oil et al). Thus if everyone is sharing the common resource which is our atmosphere, some economic cost should be associated with its use/misuse, i.e. the Pigovian Tax on Carbon emission. That is unless you are one of those who believes the earth to behave like a perfect black body which radiates all the heat entering its atmosphere back into space almost instantly, green house gases be damned.

While I am no tree hugger, I am one of those who is happy everytime the price of oil rises – demand reduces, alternatives become affordable and our moronic politicians in Washington see a little more reason to look at that crazy little thing called public transport. Thanks to this article, I feel much less of a tree hugger and in esteemed company.

Also, Greg Mankiw explains here why that absurdity of chopping off the pinkie of the invisible hand aka Windfall Profits Tax is hardly Pigovian. I wonder how much part Jason Furman, a former student Prof Mankiw’s and one of the top people along with Prof Goolsbee on Obama’s economic team, played in this policy. But then, polictics can make even economists change their belief – give the people what they want!

The Basics of the Falling Dollar

Filed under: Economics — Bottom's Up @ 1:42 am

A nice article by Martin Feldstein covering in very simple language why the dollar needs to continue to fall, and more importantly the considerations including the price of oil and domestic inflation which would affect how much the dollar needs to fall.

Also, I would think it would be interesting to see which way the dollar curve goes in the initial period after the new president is elected. On one hand, Obama is expected to work towards ending a resource sapping war in Iraq which is steadily adding to the deficit and so would be good news for the dollar. On the other hand, his populist promises and Big Brother spreading the money love all over the place wont bode well for inflation and the deficit.  Instead, one would think a republican would be good. While Wall Street would prefer a republican, John McCain would love to continue his war and start a few more if he can help it, and cares trifle little for the economy at home. Now since the people who would affect the dollar are not on Wall Street but probably somewhere close to the Birds Nest stadium, it would depend on what they think of John McCain.

June 29, 2008

Capital Inflows In China

Filed under: Economics — Bottom's Up @ 11:47 am

This article on capital inflows in China touches upon issues relevant to the conditions in India too.The issue is that the differential in interest rates between dollar and yuan results in inflows. To maintain the exchange rate, the PBOC sterilizes the yuan and this results in more money in the market and thus inflation. Recent appreciation in the Yuan has fueled more appreciation expectations resulting in exacerbation of inflows. The solution as per the article is to do a relatively larger appreciation of the Yuan which would suck out excess money from the market and also subside future appreciation expectations.

Coming to India, the current rate after the latest hikes is 8.5%. This is a substantial differential with respect to the dollar at 2%. On the top of it, with the WPI sitting unpretty at 11%, the need of the hour is to raise this even further to counter inflation problems. Now raising interest rates is a good thing (though the mismatch between repo and reverse repo rates is not). Thus while rates are being raised to counter inflation, this would increase inflows. With the current policy of sterilization, this would be counterproductive and work to raise inflation. In recent times, the RBI has increased the cash reserve ratio (CRR)  a little to tackle the issue (something which China is doing too) but they can do this only so much. Thus unless the RBI changes its policy and starts letting the Rupee appreciate, it will be not very effective in countering inflation. In a normal scenario this would all be good if the RBI just listened. However, with investors starting to get a little bearish about emerging markets, the demand for the Rupee may go down. On the other hand, with recent corrections in the Indian equity markets, FIIs may not feel as bearish after all.

June 13, 2008

Speculation, schmeculation

Filed under: Economics — Bottom's Up @ 9:03 pm

The NYT has an article on the role of speculation in the commodity markets. The article goes on to talk about various opinions on the same. It even mentions Mr Masters view that speculation is only on the buy side. However, it does not address the contradiction with the first principle of futures markets – that contracts expire and unlike stock and bond markets , unless you dump your holdings you end up with a barrel of oil or a sack of grain or whatever at the agreed to delivery point. And if speculators are indeed forced to dump their holdings pre-delivery (I assume they do not want to hold on to their sacks of grain), there is only so much and so long that speculation can drive up costs. Now, speculation if existing would result in hoarding of commodities. However, as Ajay Shah points out and as Martin Wolf’s graph below shows, global inventories in food grains went down not up.

That and there is this other problem with the speculation on speculation

Thus, a pension fund that wants to put no more than 2 percent of its assets in commodities will have to sell some of its stake when its value rises above that percentage limit.

So, as in other markets, these investors “are stabilizing forces because when the asset goes up in value, they sell some to put their portfolios back into balance,” he said.

As for Mr Masters assertion, when asked about it he said that hedge funds and such were indeed starting to buy commodities for real (and I guess hoard them). So far, we’ve not seen much evidence of this but if he is indeed correct, then it would be a lot easier a problem to fix than if he is not.

June 1, 2008

Rising Oil Prices – Don’t You Just Love Them

Filed under: Economics — Bottom's Up @ 11:30 pm

The demand supply pricing love triangle is indeed a wonderful one.

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