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April 19, 2012



I'm having trouble following this line of thinking:

"For the car example, the business model indicates that the most economical way for the entity to acquire an engine would be to buy a car, chop it up, and sell all of its parts except for the engine. Thus, the marginal cost of an engine might be essentially zero – and the result would essentially eliminate the gain recognized in the second journal entry. Indeed, the loss recognized in the second journal entry by this logic would be the telltale sign of a flawed business model."

First of all, how would the marginal cost of an engine be essentially zero? Then secondly, where would a loss in the second entry come from?

Regarding "...but if the accounting for securitizations had been more reasonable, we would already have reasonable answers" - after having read your post, I am completely convinced that the biggest piece of the problem has nothing to do with the current accounting mechanics (and I also do not think the car analogy is a good one); rather, I think it has everything to do with #4, which you interestingly did not address. For, if management/3rd party valuation firms/auditors would have appropriately valued the warranty obligation options, then the results would have been roughly accurate (on a net basis).

Tom Selling

The marginal cost of the engine is essentially zero because it was acquired in a bundle as it were with the other parts. The loss in the second entry would come from the fact that there would be no $7,000 debit to "engine" -- and the gain/loss is, of course, the amount needed to plug the entry.

I agree thta #4 is also a problem. I didn't address it, because I had already hit 1700 words, and I thought the solution was obvious.

The actual contribution of each error source to securitization accounting that has resulted in gains is an empirical question. My view is that wherever the accounting is wrong, or auditors are lax there will be some issuers of financial statements that will want to exploit it (and destroy corporate value) for their own personal benefit.

Virginia Accounting Services

The markets are particularly watching those rules as the FDIC has already acted, triggering industry concerns over regulatory overlap generating additional costs to securitizers.

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