THe current accounting procedure for valuing ALL market based securities is to mark to market their values regardless if they are being held to maturity.
This creates huge volatility in the reported P&L's. I have no problem with the procedure of mark to market pricing of securities used for speculation or even for investment purposes.
I do have a problem when a company uses market securities as a means of HEDGING a position and has the intention of holding that security to maturity.
To give you a very simplistic illustration imagine if a company enters into long term SWAPS to hedge its interest rate expense. This makes financial sense because the company wants certainty over its interest expense up to maturity, its not means of speculation but a prudent cash flow management technique. Now with interest rates droping around the world, companies are being forced to book massive losses on the SWAPS even though they have NO IMPACT on the cash operations of the business nor, over the course of maturity, on the P&L.
In simple terms imagine i took out a loan due in 5years with interest expense being the RBA interest rate. Lets say 5%. Now to be prudent i enter into a 5yr SWAP to hedge my position at 5%. Thus i pay a fee and i know for the next 5 years my rate is fixed at 5%.
Now lets say interest rates drop to 2% a year later. I would have to pay the current 2%RBA rate but because of the swap i would also pay an insurance rate of 3% (to equal the agreed SWAP rate of 5%). This is all good because i chose to fix the rate at 5%.
But under current accounting regulations i have to book a loss equal to the value of the swap insurance rate of 3% multiplied to the end of the hedge position (4years). This would all apear as a loss in the current years P&L statement.
You can see an example of this with GPT, for 2008 they incurred a "loss" of $720million due to mark to market of their interest rates swaps, even though the purpose of these swaps was to fix the interest expense, NOT to speculate.
Now with banks and financial institutions its a hell of a lot more complicated, but the end result is what proportion of the losses being reported are due to crazy rules such as these.
And the example i provided was a pretty straight forward simplistic one, its gets far more complicated when you have securities that have minimal market dept at the moment. The computed results become just crazy.
The accounting bodies are looking into this this month and hopefully we will get a more sensible outcome soon.
(20min delay)