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I am about to forensically pick apart  Goldman Sachs for my subscribers. I am posting this quick update and explanation of the new FASB mark to market rules in the mean time and will start posting Goldman stuff later on tonight. This is good stuff peoples, hard to find elsewhere in the blogosphere.

FASB given more flexibility to the management of financial institutions in valuing debt securities and has provided for increased disclosures regarding security valuation.

Determining Fair Value

When the volume and level of activity for the asset or liability have significantly decreased

Example: Company X used to value its RMBS tranche, of which was previously traded through a brokered market, via completed transactions; however, trading volume was infrequent, with only a few transactions per month and the company now decides to value the security not based on the actual transacted price but based on a market value approach (of similar securities after adjusting for risk premium) and / or present valuation technique. As a result the RMBS tranche initially reported as part of level 1 assets would now be part of level 3 assets with valuation subject to management's discretion. Thanks to new media publications and blogs such as, prudent investors are wary of mass movement of assets into the level 3 category.


The transactions that are not considered orderly

Thus in determining the reference transaction more discretion is given to management, particularly in the interpretation of what an "orderly" transaction is. Be aware that I feel that some fire sales are orderly transactions if the entire asset category is on fire.


Treatment of Other than temporary

If the fair value of a debt security is less than its amortized cost basis at the measurement date, U.S. GAAP requires that an entity assess the impaired security to determine whether the impairment is other than temporary.


The difference between the present value of the cash flows expected to be collected and the amortized cost basis would be referred to as credit losses while remaining other than temporary impairments would be due to other factors.


When an "other-than-temporary" impairment has occurred, the amount of the other-than-temporary impairment recognized in earnings depends on whether an entity intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss.


If an entity intends to sell the debt security or if it would be required to sell the security before the recovery of its amortized cost basis then other-than-temporary impairment shall be considered to have occurred. In these cases other-than-temporary impairments would be charged into earnings. This leaves entities with large AFS (available for sale) securities portfolios exposed to accounting risk from this rule. Of course, the economic risk remains the same for all. A loss is a loss, is a loss.


If an entity does not intend to sell the debt security nor would it be required to sell the security before the recovery the other-than-temporary impairment shall be separated into the following: