Thursday, October 23, 2008

Origin of Crisis (Part 2)

In chapter one of 'Freakonomics', the authors explore the incentives behind cheatings in honour sports such as Sumo Wrestling, the national sport of Japan. It derives the conclusion that if the income distribution within specific industries varies greatly between the top and bottom, individual players have great incentive to cheat or cause the system to work in its favour. This is especially true if the industry regulators also have vested interest in tolerating unbecoming behaviours. (for more coverage of the Sumo scandal beyond the book, listen to an audio report by The Economist.)

The chapter provides statistical evidence and present the case convincingly. To solidify their proposition, the authors present in the same chapter some empirical evidence that, under the above mentioned condition, even school teachers cheat in exams- no, not exams they sat as students, but on behalf of students they teach in exams that they invigilate.

If there is a common theme between cheating teachers and sumo wrestlers- indeed if there is a common theme for the book, it is "Incentive".

And that, in my opinion, is the single most important reason behind the financial crisis that we are witnessing. The tsunami begin to gather force many years before and show of all its latent power in the past year. Over the next few postings, I will attempt to document events that I think contributed to the crescendo of financial destruction. I will begin recounting from 1998 (though it might have begun earlier)...

Tuesday, October 21, 2008

Origin of Crisis (part 1)

I was listening to BBC radio on Saturday and the presenter was interviewing an economist about the financial crisis. In answering the presenter's question on whether the recent episodes in the financial world has any impact on future economic research works, the economist predicted that there will be a shift away from social topics such as 'Sumo wrestlers' to more macro-economic issues.

Obviously, he was referring to the book, 'Freakonomics', in which there is a chapter on the author's research into the behavioural science of Sumo wrestlers. Indirectly, he implied that these are peripheral studies which may not mean much in steering the future world economic direction.

I cannot disagree with his view more. The ideas behind Freakonomics are extremely relevant to to present economic mess and, dare I even suggest, probably the origin of the crisis.

More later...

Tuesday, October 14, 2008

Paul Krugman

As a reader who follows Professor Krugman's writings (especially his analysis of the Asian economies before and after the 1990's crisis), I am really pleased about his winning the Nobel Memorial Prize for Economic Science. A sampling of his work- a public lecture that he gave in 2004, may be downloaded at http://forum.wgbh.org

And because of his high public profile (he is a regular columnist at NYT) and his consistent criticism of the Bush Administration and the conservatism in public policies, there are naturally some criticism in the Swedish Academy's decision in giving out the award, especially in the time of financial great unraveling (pun intended). One example is the austrian economists blog.

Sunday, October 12, 2008

Crisis in Iceland- the hot soup that was boiling for a while

The collapse of the Iceland economy, sudden as it seems to those of us who reside outside of Europe, has been foretold many months ago, as reported by the International Herald Tribune in an article dated 17 April 2008.

For those of us residing in Asia and have witnessed the financial crisis in the 1990's, it is much the same- an economy built on borrowed money and time.

I wonder if Multi-Level-Marketing is recognised as unethical business model for private individuals and enterprises, why is the concept, when applied to international finance, deemed acceptable and legal?

Monday, October 6, 2008

Next Change: Mark-to-Market Accounting in EU

It is reported that, after SEC in the U.S. relaxed the Mark-to-Market accounting rules, EU is also looking into changing the application of the valuation method, particularly to the banks and financial institutions that carry on their Balance Sheets substantial amounts of sub-standard assets.

The logic is, I guess, by lifting the requirement for revaluing the carrying amount of such assets which would erode the accounting capitals since the book values are substantially below the assets' market value, the capital adequacy ratio of these institutions would be in much healthier shape.

But should the marketplace be sophisticated enough to differentiate between accounting capital and economic capital?

Besides, mark-to-market has already been practiced form years resulting in many of the assets being carried at previous periods' market prices.  So, if mark-to-market were to be suspended and if historical prices were to be adopted, these assets will have to be revised down also.  Given the inflated prices go back several years, these assets will have to be written down to historical prices which in effect neutralises the original intension of the suspension.

Or would the authorities then say: " higher of the historical or market value"?

Wednesday, October 1, 2008

Mark-to-Market Accounting- developing story

It seems that the accounting principle of fair-market accounting, a.k.a. mark-to-market accounting, is roundly criticised as the cause of the financial crisis.  To the extent, as reported by Financial Times, IAS will have to hold an emergency meeting "to discuss certain topics made controversial by the credit crunch- including "fair value" and off-balance sheet accounting."


Further, it has just been reported the U.S. politicians are exerting pressure on SEC to suspend the accounting practice.


I think in times of desperation and in hope of finding a silver bullet, some of us may reach out and suggest or implement solutions that seemingly tackle the symptoms without necessarily finding the cure.


Accounting, in a nutshell, is just the presentation of the financial status of a company using a specific set of measuring rules.  It does not change the underlying qualities of the assets and liabilities of the company.  In other words, whether fair-market accounting is adopted or not, the quality of the subprime mortgage assets are unchanged.  So, if we assume that the crisis is fundamentally due to the asset qualities at the financial institutions, we should deal with the cleaning out the houses and not just wiping the windows.


Besides, if one were to repeal the use of fair-market accounting, as I have previously written, we should also retroactively restate the previous financial years' financial statements in which excessive profits are recorded by adopting fair-market accounting.  In that case, is there any way we can recoup the bonuses paid out to the Management for their 'good performances'?