Level 3, FASB 157, and my 10 Taxi Cabs

Starting tomorrow, the rules for how a company carries a particular asset on it's books is going to change. 

The Financial Accounting Standards Board

These are the guys who set the rules for all accounting here in the United States.  I'm talking about FASB 157.   If you go to the website you can download the 158 Page document and read it for yourself, or I have a metaphor to illustrate what it is and why it's important.

Put on your Metaphor Hats...

I own a Taxi Company, Mike's Taxi Service.  I have 10 Taxis.  I bought the Taxis's over the last couple of years.  Each Taxi cost me $10,000 (they are very cheap taxis).

Using basic math skills, you can see my 10 taxi fleet cost me a total of $100,000 - right?

Unfortunately, I hired the wrong cab drivers.  It seems they never checked the oil and now half of the fleet is broken down with blown motors.  If I needed to sell my broken Taxi Cabs I might get $500 each in the state they are in.  Since  they have blown motors, my Mechanic Louie has resorted to calling them  "Non Performing Assets".

Along comes Nick.  He wants to buy my company and asks to look at my financials to better gauge the true value of my company.  My books show that I bought 10 Cabs for $10,000, I have depreciated them a little bit over the last couple of years ($1,000 total) so according to my accountant, the Mike's Taxi Fleet is worth a cool $99,000!

Hey, I know it's not their true and realistic value, but it looks cool on the Quickbooks Balance Sheet and as a side benefit it also looks like I'm doing really well!

After Nick  reviewed my books, he bought my company for full book value  - $99,000.  Only problem was that a week  later he found out about Louie's "Non Performing Assets" in the back of the garage.  Boy was Nick mad.  The real value of the 5 blown up cabs was more like $2,500 - not the $49,500 I was showing.  Oooops.  Sorry Nick.

REALITY BITES

In real life my metaphoric Taxi Cabs symbolize large securitized pools of mortgages.  And as you might guess, like my Taxi's, some of those mortgages are not performing so well.  Their value might not be all they are cracked up to be.  How that value is determined was somewhat up to various levels of interpretation.  What the banks, pension funds, hedge funds used to do is dump all these broken bits into a big bucket called Level 3.  They hid the bucket in the back of the garage.  They put a value on that bucket, much like I did with my broken down Cabs.  And this used to be perfectly OK.

Starting November 15th, the rules set forth by FASB 157 change how that value is determined.  They are shining the light on these buckets and we'll now get to see what's really in there and more importantly what the bucket is worth.

SMALL BUCKETS AND BIG BUCKETS

Here's a fun little tidbit I ran into the other day.  It seems most all the boys have buckets.  According to their SEC filings (Form 8-K) some of them have pretty big buckets.  Remember Merrill Lynch announced a couple of weeks ago that they had discovered they had a bigger bucket?   Cool.  The Merrill bucket is now at 16 Billion!

Just for giggles, here's some of the others;              

• Bear Stearns $20 Billion
• Lehman Brothers $35 Billion
• Goldman Sachs $72 Billion
• Morgan Stanley $88 Billion
• Citigroup $135 Billion  

Those are some pretty big buckets. Want a little good news?  Bear Sterns just announced the worst of the Sub Prime mess is now behind them.  No really.  They said that!  

Remember the good folks at FASB are looking out for the little people like you and me!  And on the bright side, now you know more about Taxi's, Level 3 Buckets, FASB 157, and how not to trust financial statements much more than you did before!  Cool.

Next we'll talk about other ways to hide other bad things like Herpes Sores and Super SIV Funds.