Rather than a political entity, for a moment view the United States as a massive corporation with divisions. Think of housing stock, commercial real estate, manufacturing capacity, technology, mass transportation, infrastructure, airports, power, pipelines, and telecommunication, and one can easily imagine the nation as a conglomerate of assets: US INC.
However, assets depreciate and not may be worth the value assigned by the owner. Accounting principles recognize that assets must constantly be evaluated. Enter the concept of the impaired asset:
…long-lived assets and certain identifiable intangibles to be held and used by an entity (must) be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In performing the review for recoverability, the entity should estimate the future cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, an impairment loss is recognized. Otherwise, an impairment loss is not recognized. Measurement of an impairment loss for long-lived assets and identifiable intangibles that an entity expects to hold and use should be based on the fair value of the asset. Summary of Statement – FAS 121
The accounting profession recognizes that an asset becomes obsolete when its income can no longer support it. Thus it becomes an impaired asset and must be written down to fair market value.
Telephone Companies and Impaired Assets
An example from the mid-1990s is the technological and business transition that faced US local telephone companies. As the industry sought to meet the demand for high speed data services and internet transport, regional phone carriers (the predecessors of Verizon, AT&T and others) needed to switch from the slower, reliable copper cable network to fiber optic technology. Similarly, switching went from analog to digital to “soft switches” to handle higher volumes of traffic. Recognizing that income from voice services could no longer support the sunken costs of the investment in copper cables and analog switches, the companies were required to recognize an impairment charge and write down the value of their assets. See The Future of the Regional Bells
Focusing on the Present State of the American Economy
The current state of the US economy bears a striking resemblance to the telecom industry scenario of that era. We have a boatload of impaired, non productive assets call residential and commercial real estate. Encouraged by the government’s desire to create an “ownership society” and artificially low interest rates, Americans overspent on housing. Housing prices were driven artificially high to the point where incomes could no longer support buyers’ investments in their homes. Collaterally, commercial real estate mirrored the housing boom with wildly expanding retail and office space. Again, our national income could no longer support this expansion.
Technology conspired to impair even more assets and reduce our national income. Faster telecommunications, larger and faster ships, cheaper foreign labor, and transferability of skilled labor made it feasible for offshore production and services. Again left behind were empty factories, shopping malls, office buildings and warehouses. The Midwest was particularly hard hit with factory closings and high unemployment. Returning to our corporate metaphor, US INC purchased too many assets at historically high prices with insufficient corporate income and profits to support them.
Hiding the Problem
Since FASB has suspended mark to market accounting in 2009, the banks have been the main culprit and beneficiary in failing to mark down these impaired assets. The Federal Reserve continued the deception when they purchased from the banks over $1.25 T of impaired mortgage backed securities. So now the taxpayer is another potential holder of impaired assets.
The Federal Reserve is on a maniacal quest to start QE2 (quantitative easing) to purchase even more impaired mortgage backed securities. If the mid-1990s telephone companies were the object of the Federal Reserve’s affection, perhaps they would have been buying the impaired copper telephone networks and paying top dollar.
Part II will discuss further impairments and solutions.
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Related posts:
- Is the US Economy an Impaired Asset? Part II
- Wildfires and the Economy
- 1984 in 2010
- Many Answers, No Solutions
- The Economy at Street Level
Tags: FAS 121, impaired assets, mortgage-backed securities, QE2
