How to solve the crisis – recognize intellectual assets
Have you read the recent text in the Economist by once claimed the best central banker in the world, a maestro, Alan Greenspan. Here is a quote that got me thinking outside the box about how to use accounting to solve the current crisis.
“Government credit has in effect acted as counterparty to a large segment of the financial intermediary system. But for reasons that go beyond the scope of this note, I strongly believe that the use of government credit must be temporary. What, then, will be the source of the new private capital that allows sovereign lending to be withdrawn? Eventually, the most credible source is a partial restoration of the $30 trillion of global stockmarket value wiped out this year, which would enable banks to raise the needed equity. Markets are being suppressed by a degree of fear not experienced since the early 20th century (1907 and 1932 come to mind). Human nature being what it is, we can count on a market reversal, hopefully, within six months to a year.
Though capital gains cannot finance physical investment, they can replenish balance-sheets. This can best be seen in the context of the consolidated balance-sheet of the world economy. All debt and derivative claims are offset in global accounting consolidation, but capital is not. This leaves the market value of the world’s real physical and intellectual assets reflected as capital [my bolding]. Obviously, higher global stock prices will enlarge the pool of equity that can facilitate the recapitalisation of financial institutions. Lower stock prices can impede the process. A higher level of equity, of course, makes it easier to issue debt.”
Here goes my simple idea. Because debt and derivatives net out we can assume indeed that the global market value of all listed companies together (global shareholders’ capital) reflects the current and future discounted value of physical and intellectual assets. Numerous papers show that we do badly recognizing the value of intellectual assets, it is often a residual, what is left after accounting for the value of machinery, building. We measure bricks, we do not account for brains. A lot of accounting efforts are now devoted to coping with a short-term problem of assigning proper value to derivatives. But globally it makes little difference, becasue whatever the valuation for a particular debt of derivative contract, its net value is zero; an increase in someone net worth is an increase in someone elses liability. In the global knowledge economy the increase of the market value of the shareholders equity globally consolidated can be achieved if the value of intangible assets goes up, which calls for a much better intangible assets recognition processes. So instead of allocating thousands of man-hours to deciding what the fair value of the CDO2 is we should spend more time changing accounting rules to measure intellectual assets. There are some good first steps taken in Australia, we should build on it.