I am probably the only person in the world who could sit on a bus, admiring the lovely tropical scenery, and thinking about accounting, but there you are. The scenery here is amazing. But so is accounting.
I was thinking about it because the US-Vietnam trade council, which shepherded us around Vietnam in partnership with the German Marshall Fund, was telling us about the ways in which they're trying to help new entrepreneurs get a leg up. One of the items they mentioned was teaching them basic techniques like budgeting and accounting. Communist countries developed their own systems for tracking production, all of them thoroughly terrible. This is not precisely surprising in a place where prices are meaningless and your inventory management ledger is not a tool to be used but a barrier to be got around. Would-be Vietnamese entrepreneurs haven't the faintest clue how to run a for-profit enterprise. This is true of entrepreneurs in all countries, but unlike their counterparts abroad, the Vietnamese have nowhere in their own country to learn about such things. The situation in Cambodia, as you would imagine, is even worse.
We use accounting as a synonym for boring. Actually, it's not; it's fun in the same way that basic math is--if you do it right, everything smooths itself out into beautifully symmetrical answers. But more importantly, it's absolutely crucial to running any kind of a decent company, or economy. Accounting is just the sort of institution that development types are talking about when they say that "institutions matter". Accounting is the inherited wealth of generations of smart businessmen trying to make themselves smarter. You may think our great economic legacy is the factories and railroads and steel mills that litter the landscape, but it's not; it's the system by which we tell ourselves what we've got. Europe had all that other stuff basically bombed into nonexistance, and built it all back in a couple of decades. Places without decent accounting find it hard to get anything much more complicated than a Yak farm up and running. It's certainly not possible to have a capital market rich enough to fund a developed economy.
The developing world is lucky because it can import that human capital. Europe had to build it up over 500 years or so, which is why it took England a lot longer to get to $20,000 per capita GDP than it did Japan.
The most important remittance of migrants abroad may be the knowledge and expectations they bring back with them; Tyler Cowen argues that Mexico has now turned the corner economically because a critical mass of immigrants simply expects more from governance and social institutions. The Vietnamese diaspora to America is slowly bringing a similar stock of capital home. And places like Nike factories are continually upgrading the human capital stock at every level. We toured a factory yesterday, and while Nike worries about its turnover rates, which average about 25% a year, this is good news for Vietnam. Every worker who goes to another plant brings a little bit of institutional capital with them. Over time, they, more than the construction companies, will build the infrastructure of a developed economy.
You're absolutely right about the importance of such systems. As I said in a comment to another of your recent postings, countries should think of political, legal, economic and financial (and yes, accounting) systems as technology. The same countries that rush to adopt mobile phone or computer technology argue that they can't possibly modernize these other systems because they're not part of their traditional culture.
When my MBA and undergrad. students in Hong Kong questioned whether they should learn about any non-Hong Kong banking systems or stock exchanges, because of 'cultural differences', I argued that a bad loan is a bad loan, regardless of traditions. Countries can learn from both the successes and more importantly the failures of other countries, such as the US Savings and Loan Crisis that was echoed in Japan's bank crises about a decade later.
This, from a Chicago girl?!
Why do accountants charge for debt and not for equity? Why are investments in tangible capital capitalized while investments in intangible capital are (usually) expensed? Why are accountants obsessed with accruals instead of cash?
Pacioli and his modern-day minions live to serve the banks, not the equity-holders! Long live the economic model of the firm!!!
This: "Accounting is the inherited wealth of generations of smart businessmen trying to make themselves smarter." Is, in one way profound, there is no question that Accounting, in its first steps, allows the Businessperson great insight into the operational efficiency of his firm. Yea, though, this road has been to far traveled, double-backed through thickets(see: Tax Code for starters, and our beloved SarbOx) toward destinations of wholesale In-efficiencies, a place retrograde of the original advance.
Megan,
Since you've brought up accounting, let me ask you an accounting question about the credit crunch. Articles in the financial press are proliferating about how difficult it is to value ("mark to market") the mortgage-backed CDOs on banks' balance sheets because right now there is effectively no market for them. Maybe I'm missing something here, but couldn't these securities be valued on a discounted cash flow basis, applying a suitable haircut to take into account an estimated default rate? I mean, even if no one wants to buy them now, the CDOs still represent an income stream.
'A world without people' would have countryside and no accounting. An Italian monk probably found the two harmonious for it was he who, I understand, came up with double entry acounting about a 1000 years ago.
Fred -
You're right that the assets could be valued that way, but the problem is finding the "suitable haircut to take into account an estimated default rate".
Ann,
How do you think those securities were 'valued' in the first place?
Here's a hint:
Collateral Cash Flow Modeling in Excel
The foundation of any securitization model is a solid collateral cash flow engine. XXX can create a customized collateral engine with features such as:
+Ability to run tens of thousands of loans with loan-level prepayments and losses
+Industry standard prepayment, default, recovery and loss severity methodologies, checked against the Bond Market Association's standard formulas
Custom prepayment and default vectors, if desired
+Loan-level prepayment penalty modeling, if desired
+Output tailored to suit your needs
+Available for all asset types including mortgage loans, auto loans, receivables, etc.
Collateral engines are written in Excel VBA for maximum power and flexibility.
Ann, also, you're missing the real reason why those "Level 3" (marked-to-fantasy) 'Assets' are not written-down, 'marked-to-market'...
Ann,
Those sorts of haircut estimates are done all the time. The exotic mortgages might make the estimates more challenging, but certainly not impossible. The WSJ had a great article earlier this year about an entrepreneur who makes his living in "the rock bottom of the housing market, what his lawyer calls the "sub-subprime market." ("Bargain Basement: Foreclosure Rise Boosts This Investor's Bottom Line"). This guy buys foreclosed houses from banks, a dozen at a time, for thousands of dollars each. Then he re-sells them for what amounts to a 15-year fixed rate mortgage at 12%. Even he is able to bundle and sell these loans. How? He sells them for a 30% discount, since that's his estimate of the default rate.
MEH,
Why keep us in suspense? Tell us the real reason why (some) CDOs haven't been written-down yet.
Fred,
I'd be betting, seeing that you're up on 'Mr. sub-subprime' and all, that you already have a clue, but, here's a decent take on the scene:
"How big will the year-end losses be? Wall Street analyst Michael Mayo from Deutsche Bank has suggested they could be in the neighborhood of $50 billion. Citigroup analyst Matt King pegged it at $64 billion. And Bob Janjuah, a credit strategist with Royal Bank of Scotland Group, reportedly threw out the staggering figure of $100 billion in further write-downs for the banks. He expected losses for the entire market could be as much as $500 billion...
...And in an environment where markets have virtually frozen for a wide array of financial instruments, the information is now a lot less reliable. “We may have reached the natural limits of what accounting can do as a model,” said Michael Kraten, a former auditor with Deloitte & Touche and now president of Enterprise Management Corp., a management consulting firm...
...With the recent, arguably late, downgrades of structured products by the rating agencies, those models will spit out much lower values for the securities in the fourth quarter. However, no two banks use the same models or make the same assumptions. “There's a lot of judgment involved in valuing level three assets, and there's a lot of variation in practice,” said Mr. Witt.
The auditors will have their hands full with year-end audits. The American Institute of Certified Public Accountants issued guidance for auditors in dealing with valuation issues in June, though it won't become effective until next year. The industry's new trade group, the Center for Audit Quality, weighed in on the issue last month with a report on fair-value measurements in illiquid markets. (See “The Secret Behind Wall Street's Q3 Profits,” FW, Sept. 24.) It gave notice to corporate executives that prices in trading markets, regardless of how thin the markets may now be, can't be ignored. Nor can the discounts that the market is applying generally to financial obligations. “They were getting out in front of the issue and telling companies that they can't hide behind a valuation model and hope that liquidity returns to the markets,” said Kevin Mixon, an analyst with RiskMetrics Group.
Whether they have the ability to assess the accuracy of the thousands of Ph.D.-engineered models that the investment banks typically use to value assets is an open question. “The auditors have some smart people,” Mr. Kraten said. “But they're outgunned in this.”
So what will year-end financials reveal about the health of the investment banks? Go ask Alice. FW
http://www.financialweek.com/apps/pbcs.dll/article?AID=/20071112/REG/711100303
Banks in the frying pan
How bad are the big banks' loan losses? Depends on how good their accounting models are. Auditors are about to weigh in. Will it be fair value at work or fear value at its worst?
By Andrew Osterland
It has been a few years, so I don't recall where I heard it, but I was listening to a discussion of the most important inventions in the history of man, and one of the highest listed was double-entry bookkeeping.
Another great invention is corruption.
Not that corruption is a good thing, the IDEA of "corruption" is great. The very concept that someone with political and/or administative power should NOT being doing everything he can to help his friends and family.
This took centuries to solidify into a clear concept of duty and honesty. One that still hasn't been adopted everywhere.
As soon as people bother starting to hide their corruption, you now are starting to make progress.
[Would-be Vietnamese entrepreneurs haven't the faintest clue how to run a for-profit enterprise. This is true of entrepreneurs in all countries, but unlike their counterparts abroad, the Vietnamese have nowhere in their own country to learn about such things.]
apart from the ethnic Chinese community who have always formed the majority of the business class throughout SouthEast Asia, just like in Malaysia, Indonesia and Thailand.
In related news, the tracking and management systems of doi moi weren't/aren't terrible, and the whole "it's impossible to run an entrepreneurial business within a communist system" thing really does have to explain quite how China manages it.
"the whole "it's impossible to run an entrepreneurial business within a communist system" thing really does have to explain quite how China manages it."
The conventional wisdom in China is that one needs to either operate at very high or very low levels. If you bribe someone at the very top, he can protect you when lower level bureaucrats come after you. If you only bribe one agency in the middle (even though that seems to be the key agency for your industry), other agencies will crawl out of the woodwork to extort money from you, so you need to pay off someone sufficiently powerful to limit the overall bribery cost.
Or, in some cases, you can operate on such a low, local level that the rest of the bureaucracy doesn't even notice you. Then you only have to bribe local officials.
By the way, on my earlier 'haircut' comment, I wasn't saying that such discounts are impossible to calculate, simply that they are the primary challenge to valuing such securities. Fred seemed to be implying that such procedures are easy, but figuring out the right haircut can be difficult. With an actively traded market, you can simply use the consensus of other people's estimates of the appropriate discount, since the market aggregates those opinions. Without a market, the accountants might have to make their own forecasts, and such estimations aren't the primary expertise of accountants.
Owning a vehicle is every traveller’s dream but it can get tougher for people whose credit ratings are not up to the mark. A bad credit loan at extremely low interest is your tool to owning a car.As for secured loans, on account of proper security, the loan can easily be paid back in 5 to 25 years. An unsecured loan will be at a comparatively higher rate, shorter repayment duration and lesser loan amount.To find bad credit auto financing,online auto financing visit http://www.consumerautofinancing.com
Owning a vehicle is every traveller’s dream but it can get tougher for people whose credit ratings are not up to the mark. A bad credit loan at extremely low interest is your tool to owning a car.As for secured loans, on account of proper security, the loan can easily be paid back in 5 to 25 years. An unsecured loan will be at a comparatively higher rate, shorter repayment duration and lesser loan amount.To find bad credit auto financing,online auto financing visit http://www.consumerautofinancing.com