Mark-to-Market Accounting explained – using cows.
by Benjamin on May 12, 2009
Seth Godin's Purple Cow... It's amazing what cows can be used for these days
The Business Insider ran a brilliant set of articles explaining AIG’s bankruptcy and what ‘Mark-to-Market’ accounting really is, and how it can be so deceptive – because it seems we didn’t learn much when Enron was allowed to use that accounting system a couple of years back. Anyway, the SEC seems to think it’s a good idea to revise or suspend the rules regarding Mark-to-Market accounting, so Business Insider ran a great overview of what that really meant – using cows:
-You have two cows.
-You write down on a piece of paper that the cows are worth $100 each.
-You notice the cows are on fire.
-Your paper still says $100.
-Fortunately, mark to market has been suspended so you don’t have to pay attention to the fire.
-Your cows are dead from fire.
-Your paper still says $100.
-Fortunately, mark to market has been suspended so you don’t have to pay attention to the dead cows.
-You notice that you aren’t getting as much milk as expected, so you adjust the model and mark the cows down to $98. You are confident, however, that the dislocated stream of milk revenue will quickly revert to expectations.
-You need to borrow some money so you ask investors for a loan against the cows. The investors tell you the cows are dead, and you already owe them $200 dollars you borrowed to buy them in the first place. You show them the paper that says the cows are worth $98 each.
-They light your paper on fire.
-You ask the government to buy the dead cows at $98 each.
-The government holds meetings all weekend and finally comes up with a plan to inject $45 dollars into your cattle ranch. In exchange, the government gets a right to milk generated from the cows at some point in the future. It expects you’ll buy a new cow with the $45.
-You have two dead cows, $45 and $200 in debt to your investors. You have no plans to buy new cows.
And that, ladies and gentlemen, is how we can amass a huge amount of debt with very little to show for it. The Business Insider is kind enough to provide an update with the April Financial Standards Accounting Board meeting to further revise these rules also using two cows, and also a quick overview of the AIG collapse.
Tags: AIG, Cows, Mark-to-Market, The Business Insider
and as far as I understood, the nice story continues like this: the investor relises that you have no intention to buy new cows and pay your debt back, so he sells your debt to another bank for good money. Because you actually dont pay the debt back, investor II asks government to pay it for you. :D