Wednesday, February 25, 2009

XBRL Could Have Averted Much of the Current Economic Mess
by Gerald Trites

As we all know by now, the immediate cause of the financial downturn was the proliferation of asset backed securities without any real assets with actual value to back them. One example is that of collateralized debt obligations (CDOs), which are "mortgage-backed securities blended with other assets—say, auto loans or credit card debt—into one asset-backed pie, sliced up according to risk and sold as an investment." (1)

The problem with these and other securities is that it is all but impossible for investors to figure out what assets are actually there, and what they are worth. In order to find out, they need to drill down through multiple layers of securitization. Now, this in itself does not sound like an impossible task, but the problem comes in sifting through the information formally disclosed about these securities. For example, the rules require a prospectus to be issued on particular securities, but much of the content of these prospectuses is in narrative, and very complex and lengthy. Documents of hundreds and even thousands of pages are not uncommon. Even very sophisticated and trained investment professionals found this to be all but impossible to work with.

So we had investors placing their money into securities for which they had no idea what they were actually investing in.

OK, this is all old hat now. We know that. The financial disclosure system has become so obfuscated with excessive narrative detail that it is all but impossible to decipher. It has lost its transparency, and this in an age where transparency is needed more than ever.

But lets say that the loans data were tagged using XBRL tags. If they were, users "would have been able to track their circuitous route through the financial industry and judge each CDO based on its actual content. They could have seen which loans were in default and which weren't, which CDO was overweight on Las Vegas real estate and which was in the relatively safe Louisville market. An amateur risk assessor could have separated the junk assets from those worth keeping and either bet against the companies holding the garbage, blogged about it, alerted the Feds—or all of the above."(1)

A major advantage of XBRL is that it enables data to be defined, placed into context and then transported easily through a reporting system, all the while retaining this context. That means that assets that are impaired are identified as such and that information remains with the data. Even if the status of the assets changes, once the data is tagged, the status can be easily updated.

The conclusion one has to reach is that, if the data around these complex instruments had been tagged, investors could have quickly seen through the instruments and logically not made the investments. Just think of the impact this would have had on the financial shakedown that has taken place. Admittedly, there might have and probably were other economic factors lurking in the background that might have caused a slow-down. We were probably due for one anyway. But also think about how much less severe it would have been if the financial system hadn't had to go through the cleansing it is now trying to endure.

In other words, XBRL has the capability to make the financial reporting system transparent again. We need that.

Mortgage backed securities, and similar investment vehicles are a prime example of the way in which having tagged data can help interpret complex data. Another example is the regular financial statements and MD&A documents we see every day. These vehicles are becoming more and more voluminous and difficult to analyze and interpret. So the normal financial reporting process is also losing its transparency. XBRL is a way to get it back.

There is more on this aspect of XBRL, in particular how it might have forestalled or mitigated the current economic crisis in a recent article in Wired magazine. It's worth careful consideration, not only by analysts and investors, but by regulators as well.


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