Twitter Fair Value Accounting

Do you still believe in 'Fair Value Accounting' or 'Market Value' as an excellent accounting principle?

After reading this blog you'll probably have developed a more distinguished view....

Yes...,Fair Value is hard to define...

Probably 'The Fair Value' as such, doesn't exist.

What's 'fair', is often subjective. Therefore 'Fair Value' must be imaginary.


How to earn $9 million by investing '50 cent'?
Answering this question is easy. Look at the next example:

According to 'Business Insider', rapper and business man 'Curtis James Jackson III', alias '50 Cent', promoted the almost worthless HNHI shares during the first weekend of 2011 on Twitter with success!
In no time HNHI shares, including Curtis' 30 million own shares, went up by $.29 a share. Result: almost $ 9 million gain in market cap for just one weekend of tweeting. Not bad!

What actually happened, was:

Don't replicate these kind of dangerous investment marketing jokes...

It's like playing with fire and (therefore) not without risk.

The SEC's attention for Curtis James Jackson's discussable marketing promotion has already been drawn...

Twitter is great, but use it for social activities. Always 'Mind your Steps' at Twitter, especially with regard to financial issues.


Fair Value
This controversial simple Twitter-Investment example shows the weakness of our accounting system. 'Fair values' are of course by definition 'fair', but can be easily influenced by major media players like celebrities or large investment companies in the financial markets.

Controversial Investment marketing
The wrong receipt (Fraud?) to make profit in the investment market is:

1. Select a listed company XYZ in your portfolio that didn't perform well during last years and is clearly undervalued.
2. Hire a celebrity (on basis of a limited fee) to promote XYZ on Twitter.
3. Wait for the shares to go up
4. Cash out before shares go down, ahead of a total collapse. 

Large Investment Companies
Of course - just like me - you might think: large companies don't get mixed up in these matters.  But what to think of the next, slightly changed, approach where large investors makes use of the effect that a lot of small investors follow (or try to outperform) a large investor by flocking (following) or anticipating a large investor's investment strategy without an own investment policy or model (Fair or Fraud?).

A large investor can easily use this flocking effect in a kind of double trick:

1. As a large investor: Select a listed company XYZ in your portfolio that didn't perform well during last years and is likely undervalued.
2. Simulate in the market that your large investment company is interested in buying XYZ shares (spread the rumor, place a non binding call, etc.) or invest a small amount in XYZ.
3. Wait for the shares to go up.
4. Cash out before shares go down on their way to a total collapse.

Case 'Deutsche Bank'
Again, if you don't believe these kind of methods are applied, just go to sleep early tonight and please don't read the 2010 introduction in FT of new computerized trading model called 'Super X' by 'Deutsche Bank'. This new model is all based on 'dark pools'. Nobody really knows or fully understands what is happening in these dark pools and their corresponding algorithms. What about transparency rules? Unfortunately you'll find not a single word about Super X ethics in press articles by Deutsche Bank.

Understandable, because Deutsch Bank doesn't have to worry about transparency or ethics at all. Despite of its ethical code, ominous named 'Passion to Perform', Deutsche Bank admitted criminal wrongdoing over fraudulent U.S. tax shelters by the end of 2010.  Instead of firing those who where responsible, DB simply agreed to pay $554 million to avoid prosecution. After that it was business as usual......

How far does 'passion' go? What seems 'fair' to you and what can we actuaries, learn from this?????

Ethical?

Like in the example(s) above, large investors are able to influence and manipulate the market (price) by acting, fake-acting or non-acting.

From an ethical point of view it gets more and more complicated to earmark such actions as unethical.

Computer programs simply register effects as "if I (computer) do (invest or not-invest or disinvest) 'so', 'this effect' will be 'the result'.

As a consequence these computer programs simply apply and execute these found market principles and structures in the financial markets without a 'moral view' or any form of perception: Fair!, so to speak(??).

Monetary Policy Influence 
Another form of influencing financial markets is by the monetary policy  (read:intervention) of the central Banks. The 2010 Fed intervention could be such an example.

Conclusion

It's clear that the financial markets can be easily influenced by short term media effects, indirect value related investment strategies of large investment companies and Central Bank's monetary policy.

Irrespective from the question wetter it's "Fair Value or Not Fair Value", we'll have to deal with 'temporary unfair market effects' that can have a major impact on a company's value.

As a consequence it's not 'fair' nor 'wise' to base a company's value on the 'fair value' on December 31th 24.00 hours. Temporary market volatility should - one way or the other - be excluded in valuations (moving average?).

With regard to your own private investments or life, keep in mind:

If something sounds too good to be true …
it probably is...

Related Links/Sources:
- How To Make $10 Million From Just One Weekend Of Tweeting
- "If it's good enough for Buffet, it's good enough for me"
- "No Amount Of QE Will Be Able To Keep The Current Stock Market Bubble From Bursting"
- Fair Value or Not Fair Value
- How Much Influence Does The Fed Have?
- Fraudwatchers
- The Latest Celebrity Stock Promoter / Pump and Dumper? 
- CurtKoCool 
- Cartoon '50 Cent' 
- MarketWatch HHI
- FT: Deutsche Bank unveils new trading model (2010) 
- Daffy Duck 

Coastline Fair Value

Close your eyes and take a guess at the Australian coast length? Answer : 'Exactly' 25,760 km.

1. Right, according to Wikipedia
2. Wrong! Because the exact coast length depends on the length of your ruler!

If you would measure the Australian coastline with a 1-mm ruler, you would get a length of more than 100 .000 km!

This leads to the question:

Does a 'coastline fair value' exist?

After all, as the ruler gets diminishingly small, the coastline's length gets infinitely large.
This phenomenon is also known as the Richardson Effect (or the coastline paradox).

Coastline Formula?
In 1967 a document called "How long is the coast of Britain?" was published by the great mathematician Mandelbrot

In 1967 he revived the original formula, earlier developed by Richardson :

L(G) = F . G^(1-D)

with

L=length of the coastline as a function of G

G=Ruler length

F=positive constant factor,
D=constant (D>=1). D is a ‘‘characteristic’’ of a frontier, varying from D=1 for a straight frontier to D=1.25 for a very irregular coastline like Britain. It turns out that D = 1.13 for the Australian coast and D=1.02 for the very smooth South Africa coastline.

Fractals
The constant D also stands for 'Dimension' and in 1975 Mandelbrot develops this Dimension- idea to what is called the Fractal Dimension.

Fractals turn out to be the perfect (math) language for describing all kind of natural phenomenas like leaves, trees , etc.

Fractals are even used to describe the stock market, the credit crisis or the coastline of the law.


Coastline Formula & Valuation
What can we learn from this fractal coastline measurement with regard to valuations?

1. Stop changing the rules
   If accounting standards like IFRS , GAAP and IAS or legislation are constantly changing (e.g. amendments) and getting more and more specific, valuing a company becomes like measuring the coastline with different rulers.
   
   In this case management, supervisors, stake- and shareholders lack a sustainable view on their business. You can't justify the results and value of your company if you have to measure yourself with a dynamic ruler!
   
   
2. Stop digging
   More and more deep going risk research will eventually lead to an substantial increase or even 'infinite' Value at Risk.
   
   Therefore it's important to define portfolio-, market- and product-risk- limits and structures first, right from the companies (risk) strategy.
   
   These instruments reduce the needed depth of risk research and therefore increase the control- and efficiency-level of the company.

Try to think scale free and have fun by applying fractals in actuarial science!

Unfair Value

How can you be against something that's fair, like "Fair Value"?
What could be wrong, valuating a company at market value?

IceComp Case
Let me take you along in a story about IceComp, a fictitious ordinary wholesaler in ice creams.

The daily demand for ice creams turns out to be in line with the outside temperature. In an average summer, with an average temperature of 16°C (about 60°F), IceComp sells 10 million ice creams a year. Annual turnover the past 10 years, $ 20 million with a net margin of 10%.

In order to regulate demand and to maximize profit, IceComp defines the daily ice cream selling price (P) in line with the market by the formula:

P = DAYTEMP / 8

So at 32°C an ice cream will sell at $ 4 and at 16°C it will sell at $ 2 a piece. To always deliver on time, IceComp keeps an average stock of about 2 million ice creams. Based on on the average selling price of the last 10 years, this stock is valued in the balance sheet at $ 4 million, resulting in a fair and trustworthy P&L, that reflects the actual sales level at current prices.

Two years ago, inventory (stock) valuation based on market prices ('fair value'), i.e. the price daily selling price of an ice cream, became mandatory. From that moment on, things started to go wrong.

Consistent with the daily temperature, the daily inventory value starts to oscillate heavily, with explosions and variations up to $ 6 million per month. To the 'surprise' of all stakeholders, equally strong alternating monthly gains and losses are reported. It's crystal clear, the company is no longer 'in control'.

The national supervisor interferes and demands extra securities (funds). Now the monthly P&L of IceComp starts to oscillate even more, as the investment results of the extra securities, that principally do not have anything to do with the core business of IceComp, also start to vary on basis of 'fair value' (market prices) valuation.

Ultimately, lack of confidence from share- and stakeholders drives IceComp into bankruptcy.

Conclusion
What was meant to be 'intentional Fair', turns out to be 'Unfair' in practice. Valuing balance sheets on bases of daily prices is like playing 'Russian roulette'. It can be compared to making 'climate statements', based on the daily weather forecast.

The analogy to banking, pension and insurance business may be clear. Don't base valuation methods on daily prices, but on a, per product or market defined, 'moving average market price' for a fixed chosen period (depending on product or market cycle).

The current (credit) crisis calls for development of new valuating principles by auditors and actuaries.