New accounting makes it hard to mark-to-model

November 8th, 2007

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Yesterday, in How solvent are some of the major US financial institutions?, we paraded the solvency skeletons of major US financial institutions. We provocatively asked what will happen if all these assets are marked-to-market?

Well, November 15 is the day of reckoning because a new accounting rule (FASB 157) will take into effect on that day. Basically, that new accounting regulation will make it harder for companies to mark the value of their illiquid assets to model. The most vulnerable will be Morgan Stanley, with their marked-to-model assets worth 251% of their equity capital (assets minus liability), followed by Goldman Sachs (185%).

According to this news report in Bloomberg, this new accounting rule can result in up to $100 billion of write-downs. Nouriel Roubini reckons that $500 billion is “quite reasonable and likely” (see Credit and Financial Markets Losses: $100 billion or $200 billion? Or most likely $500 billion?).

Obviously, write downs of such magnitude are going to spook the market. Be prepared for a rough ride (a crash is definitely a possibility) ahead!