The devil comes to Norwalk February 8, 2010 at 8:50 pm
That’s Norwalk, Connecticut.
In Risk, we find:
faced with accounting changes that would result in more financial instruments being reported at fair value through the income statement – meaning changes in value would appear as profits or losses – regulators have been quietly discussing radical new rules that would separate profits into buckets depending on the liquidity of the underlying assets.
The new reporting regime would then allow regulators to restrict how gains on less-liquid instruments are used. As a result, derivatives and structured product businesses could find a huge chunk of their profits fenced away.
This is a variant on an idea I suggested earlier, and a bad variant to boot. The good thing about separating realised from unrealised gains is that only the latter are a good form of capital. If you have rigourous valuation risk management, then the P/L on the illiquid books is just as good as the P/L on the liquid ones, since both have sufficient valuation adjustments to cope with the uncertainties involved. Supervisors would be better off doing the boring (but hard) job of ensuring that firm’s are valueing their books properly, and then treating all unrealised profits as potentially suspect, not just level 2 and level 3 ones.
