Alice Through the Accounting Glass

This market gets curiouser and cursiouser.

In its last earnings report, Citigroup noted a $2.5 billion credit due to the fact that their debt is cheaper. In mark-to-market terms, they discounted their debt, and so recorded a profit. On the other hand, Morgan Stanley’s credit quality improved, so they had to record a $200 million charge. So Citi is profitable because their credit is worse, and Morgan lost money because their credit is better. As Dave Barry would say, I am not making this up.

This illustrates why the whole concept of mark-to-market has to be carefully re-thought. Sure, if Citi could buy back all their debt at discounted levels they could record a profit. But they can’t, so why should we pretend that they can? The real question is: “What is Citi’s value as a going concern?” Everything else just gets in the way of this analysis.

There are a lot of regulators who never made a loan passing judgment on banks and a lot of accountants who never had to manage a portfolio. There is no substitute for real-world experience. Let’s hope that our latest experience will make us all more realistic.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

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