Market Turmoil May Require New

Market Turmoil May Require New Ways to Build Capital

The following paper reviews the article Market Turmoil May Require New Ways to Build Capital. A synopsis of the content is given followed by a specification of the thesis's main point. Three supporting opinions/reasons for this thesis are outlined, as well as three opposing opinions/reasons. Finally, a summary and opinion of the thesis is presented.

Market Turmoil May Require New Ways to Build Capital

The following paper reviews the article Market Turmoil May Require New Ways to Build Capital (Goldman, 2009). A synopsis of the content is given followed by a specification of the thesis's main point. Three supporting opinions/reasons for this thesis are outlined, as well as three opposing opinions/reasons. Finally, a summary and opinion of the thesis is presented.

Article Synopsis:

Goldman (2009) acknowledges that financial times are changing, for the United States. He notes that the government's ownership of key industries, like: banking, housing and automobile manufacturing, will affect innovation, productivity, profitability, and growth rates. For decades the American economy has been built upon increasing leverage. However, in today's new economic world, the country is facing a significant time of deleveraging. Other countries are feeling the impact of a changing global economy too. Iceland, once one of the richest countries in the world, financially collapsed in October 2008. Inflation rates in Zimbabwe is, at the time of Goldman's writing, 11.2 million percent. Although no one anticipates the United States facing these extremes, there are concerns that are linked to the challenges of today's economy.

In September 1979, Goldman (2009) notes, the accounting world was focused on inflation accounting. As such, FASB Statement 33 was developed. Understanding that historic cost was one of the founding principles in accounting, the economic conditions became such that it impacted these figures. Today's financial reporting has new concerns, specifically with the cost of capital and calculating it in the lack-of-liquidity environment the United States is experiencing today. Add to this challenge, as Goldman surmises, "Massive government intervention distorts market efficiencies. Violently changing asset price levels, up or down, create gaps between historical averages and current market conditions" (p. 24).

The cost of capital is at the core of business valuation, according to Goldman (2009), yet today's economic crisis has changed the world so dramatically that even the IRS is showing a softer, more empathetic side. The cause of this liquidity crisis, however, is still up for debate. However, whether it's due to criminal dealings or greedy corporations, calculating cost of capital is even more important.

Goldman (2009) defines cost of capital "as the expected rate of return that the market participants require in order to attract funds to a particular investment" (p.. 25). The normal build-up method for calculating the cost of equity capital includes the risk-free rate plus a risk premium, which is further divided into: general equity risk, company-size and/or industry risk, and company-specific risk. The SEC wishes to see more information regarding a company's liquidity, as a means of gaging the organization's future prospects, for investors.

If there is one thing certain, according to Goldman, the future is uncertain. He concludes with possible concerns about future accounting items. Will their need to be a line in build-up models for currency risk? Will there be new models of capital pricing and allocation? Will the American government continue to be a major source of capital and will social costs need to be factored into the cost of capital? Is this the beginning of socialism with the government deciding which industries to bail out and which to let fall by the wayside? Goldman concludes that this is neither a credit crunch nor a recession, but instead a massive liquidation cycle that will take years to fully play out.

Specification of Thesis's Main Point:

Goldman (2009) surmises that today's economic crisis has changed many aspects of financial reporting, one of which is the calculation of the cost of capital.

Three Supporting Opinions/Reasons:

Utilizing much of his own personal, professional experience as well as other sources, Goldman's (2009) three supporting opinions all highlight the impact today's economic crisis has had. He quotes Marc Panucci, an SEC associate chief accountant, in his first supporting opinion. Panucci agrees with Goldman's theory that the turbulent economic environment of today requires changes to existing disclosures, in order to meet disclosure requirements. This is especially true when meeting disclosure requirements in liquidity, risks and uncertainties, and credit risks.

The Internal Revenue Service is Goldman's (2009) second supporting source. Not known for their empathy, the IRS has eased rules so that homeowner's facing tax liens can sell or refinance their homes. In fact, in some instances, "the IRS is willing to subordinate its interests in favor of mortgage holders" (p. 24). Of course, as Goldhorn notes, there is a 50% chance now that the federal government is the mortgage holder.

.Lastly, Goldman (2009) uses the state of the banking industry's stranglehold on capital currently as a third support for his position about how the economic environment has changed. Despite the fact that the government is giving money hand over fist to the banks, banks don't appear to be following suit. Where bankers are aggressive on the calling-loans-in front, they're much less aggressive on extending-new-credit front. Goldman notes that equity investors are nearly extinct as either their own resources have dried up or they're waiting for an even better deal. This, he purports, makes it very difficult to calculate "the cost of something (capital) that at the moment is scarcer than snow in the desert" (p. 24).

Three Opposing Opinions/Reasons: