FASB Statement 159: A Big, Fat Legal Scam

1. Set up a Company, go IPO.

2. Sell $1B bond.

3. Spread rumor of the Company's demise. Or better yet, actually run the Company almost into ground. Quickly.

4. Buy the Company's bond at $40 on $100 par.

5. Book a $600M profit, and pocket the $600M extra cash from the bond issuance.

6. Retire as a rich hero.

BTW, you don't even need to actually buy the bond in order to book the profit, thanks to the infinite wisdom of FASB (aka FASB Statement 159). Yes, the $600M profit will disappear into thin air by bond maturity, if the Company survives, that is. But who cares about next quarter, not to mention 10 quarters later. In any case, the extra cash is real if you manage to drive the Company almost into the ground faster than spending the bond issuance proceeds.

And if you can recycle these paper proceeds as cash through the Fed, you don't even have to worry about financing. Spend the bond proceeds, buy back paper, give it to Fed as collateral for cash, buy back more paper. Zero cost, zero risk, lots of reward.

This applies to loans as well, as long as they're securitized and traded on the secondary market.

In reality, it takes good research to locate current bond holders and may take some persuasion to buy them. But if the gloom looks real enough and you're crafty enough (e.g., gradually over a period of time, through a third-party broker), it can be done without raising too much suspicion.

It gets better. Once you have bought back almost all of your bond, you can set up a phony market price where ever you want.

Companies have actually bought back their bonds on the secondary market. I'm not saying any of them did it intentionally, as outlined above. But this doesn't change the fact that such scams are legal and plausible.

Unless the bond is callable, the issuer should be forbidden to purchase it on the secondary market, be it at discount or premium, and such accounting games cannot be played. In terms of interest rate risk, buying one's own bond from the secondary market is equivalent to having an embedded call option, which otherwise would result in a higher coupon. In terms of credit risk, it is equivalent to selling one's own CDS or life insurance (not considering differences in financing), it doesn't make sense, nor should it be legal, except in the wonderland of modern financial accounting and regulation.

Comments

[john s. gordon:]

thanks for the warning.
> jack

Apr 19 08:28 AM

[sieraromero:]

It is just another sign of todays free market capitalism gone wild. We need more oversight of todays financial instruments and not less government intervention. However that being said, we need smarter monitoring of these schemes by smarter employees of the government. Once these people or organizations are caught manipulating the system they should be tried for treason and punished as such,because they are destroying this country of ours!

Apr 19 08:32 AM

[sieraromero:]

It is just another legal way for capitalism and criminals to manipulate the system and reward failure and deceit!

Apr 19 08:33 AM

[henarl:]

There will always be people who will figure out how to game the existing system or change that system so it will be gameable. Unfortunately, our government and the Fed has been, and still is, being run by these people

Apr 19 01:42 PM

[Friar Hilarius:]

Some comments here indicated an understanding of the need for morality in human affairs

Please now demonstrate how debt is not a cancer, and profit gouging is not a malignant tumour

How many readers work for successful not-for-profit organisations such as colleges, hospitals and public service entities

When are we going to start realising that profits do not add to employment ... they subtract from it ?

Criminally manipulated markets are no use to any one except the profit gougers

Communism could not be worse

Friar Hilarius

Apr 19 04:51 PM

[EGGBEATER:]

IF SOME THE DISHONEST, AND GREEDY, INVESTMENT BANKERS (e.g. MERRIL-L EX-CEO) WHO BROUGHT DOWN THE U.S. ECONOMY (AND ENDED UP COLLECTING OBSCENE BONUSES) WOULD HAVE BEEN CHINESE GOVT. OFFICIALS LIVING IN CHINA, THEY WOULD HAVE BEEN SENTENCED TO DEATH IN FRONT OF A FIRING SQUAD. AND THE COST OF THE BULLETS WOULD HAVE TO BE PAID BY THEIR IMMEDIATE FAMILY.
I'VE SEEN THIS HAPPEN IN 2000 WHILE DOING CONSULTING WORK FOR A GLOBAL COMPANY.

Apr 22 12:14 AM

[Livin' in t...:]

Some companies can buy back their debt at $.10 on the dollar, instead are negotiating and taking tax money to run their businesses while in bankruptcy. The American capitalist system is under fire, we need to wake up and update current securities laws to reflect the global ecomony and the products being sold in it. The problem is, "the fox (congress) is watching the hen house". If you know what I mean.

May 01 07:01 AM