JP Morgan Chase 2008 Annual Report Download - page 24

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•A new mark-to-market rule addresses “debit valua-
tion adjustments.” Essentially, we now have to mark
to market credit spreads on certain JPMorgan Chase
bonds that we issue. For example, when bond spreads
widen on JPMorgan Chase debt, we actually can
book a gain. Of course, when these spreads narrow,
we book a loss. The theory is interesting, but, in
practice, it is absurd. Taken to the extreme, if a com-
pany is on its way to bankruptcy, it will be booking
huge profits on its own outstanding debt, right up
until it actually declares bankruptcy – at which point
it doesn’t matter.
• It is becoming increasingly more difficult to compare
mark-to-market values of certain instruments across
different companies. While it’s too involved to go into
detail here, different companies may account for simi-
lar mark-to-market assets differently. This needs to be
addressed by ensuring that companies adhere to con-
sistent valuation principles while applying the rules.
• Fair value accounting does not and should not apply
to all assets. Investments or certain illiquid assets that
are intended to be held for the longer term (like real
estate or plant and equipment) or loans and certain
assets that are shorter term (like receivables or inven-
tory) all could actually be marked to market. There
are, in fact, markets for some of these assets, and oth-
ers could be calculated based on reasonable assump-
tions; for example, a farm would be worth more
when corn prices go up, and a semiconductor plant
would be worth less when semiconductor prices go
down. However, if we marked these assets in this
way, they would have wildly different prices depend-
ing on the health of the economy or the swings in
prices for their output. While accounting should
recognize the real impairment in the value of assets,
marking the aforementioned assets to market every
day would be a waste of time. Under this scenario, it
would be quite hard for companies to invest in any-
thing illiquid or to make long-term investments.
New accounting rules that have the potential to
inadvertently affect how the capital markets function
or change fundamental long-term U.S. government
policies should be made thoughtfully, deliberately
and with broad input
For example, we all believe that companies should
have fully funded pension plans; i.e., the actual assets
in the plan should be enough to meet a fair estimate of
the liabilities. Years ago, if this wasn’t the case, compa-
nies were allowed to maintain a “deficit” and fund it
over several years. That deficit was not recorded on the
financial statement of the company.
A change in accounting rules dictated that the deficit
should not just be a footnote in the financial state-
ments but that it should be reflected directly in the
equity account of the corporation. Clearly, in very bad
markets, these deficits grow dramatically, thus deplet-
ing the increasingly precious capital that companies
have. (This is just another example of a pro-cyclical
force). When companies realized they were getting
enormous volatility in their capital account, they began
to curtail or eliminate their pension plans in favor of
401(k) plans (where the individual bears all the invest-
ment risk). This was a rational, precautionary step. But
it, in effect, transferred the risk from the company to
the individual. No longer did the large corporations
assume the risk of providing a steady income stream to
retired employees. Instead, the risk was passed to the
individuals – many of whom could not afford it.
This is a perfect example of how accounting inadver-
tently sets policy. And, in my opinion, this was proba-
bly the wrong policy for the country. There would have
been many ways to be true to the economic purpose
of accounting without making a detrimental policy
change. There are countless other examples, and we
hope regulators and accountants will eventually find
better ways to apply accounting principles.
G. The need for appropriate counter-cyclical policies
During this crisis, it became evident that our system
created enormous pro-cyclical tendencies. In fact, I
can’t think of one counter-cyclical policy at all (other
than emergency actions taken by the government).