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I'm not very well versed in how selling debt works, but the way I assume it works is the following: Say someone still owes me $1M over the next 10 years, but I

by ATsch 4y ago

I'm not very well versed in how selling debt works, but the way I assume it works is the following: Say someone still owes me $1M over the next 10 years, but I think that there's now only a 50% chance of the debt being repaid. It would make sense for me to try and sell that debt for at least $500k to get a guaranteed immediate return, right? And then that person could say that they hold $1M dollars, even though it's only worth half that much if they priced the risk into it. I may be misunderstanding things though.

nradov 4y ago
Yes that's basically how it works. When a corporation holds a loan as an asset on their balance sheet, they're supposed to mark that asset to market reflecting the risk of default. But if marking to market isn't actually enforced by auditors or regulators then the company can pretend that the asset value is the same as face value. This can appear to work for years until there's a recession and a bunch of borrowers default.
- ATsch 4y ago
  Ah, that makes sense. I'm curious though, how would auditors ensure the asset is marked to reflect the risk? If one organization thinks the risk is substantually lower than another, what do they mark? Or is there generally enough arbitrage that this doesn't happen.
  - nradov 4y ago
    Well it depends on the asset. If it's regular corporate bonds that are being actively traded on an open market (liquid) then just use a recent market price. If there's no market then valuation becomes highly subjective. If the borrower has some kind of credit rating from a trusted rating agency then that can be used as proxy for default risk. Or if the borrower is publicly traded and releases audited financial statements then you can estimate based on those. But if you don't have any of that then pick a number and try to get the auditors to swallow it.
charcircuit 4y ago
>And then that person could say that they hold $1M dollars You don't own $1M dollars, you own debt which is an asset. Considering you just bought it for $500k it sounds like the market price for that debt is $500k.

by ATsch 4y ago

nradov 4y ago

Yes that's basically how it works. When a corporation holds a loan as an asset on their balance sheet, they're supposed to mark that asset to market reflecting the risk of default. But if marking to market isn't actually enforced by auditors or regulators then the company can pretend that the asset value is the same as face value. This can appear to work for years until there's a recession and a bunch of borrowers default.

ATsch 4y ago
Ah, that makes sense. I'm curious though, how would auditors ensure the asset is marked to reflect the risk? If one organization thinks the risk is substantually lower than another, what do they mark? Or is there generally enough arbitrage that this doesn't happen.
- nradov 4y ago
  Well it depends on the asset. If it's regular corporate bonds that are being actively traded on an open market (liquid) then just use a recent market price. If there's no market then valuation becomes highly subjective. If the borrower has some kind of credit rating from a trusted rating agency then that can be used as proxy for default risk. Or if the borrower is publicly traded and releases audited financial statements then you can estimate based on those. But if you don't have any of that then pick a number and try to get the auditors to swallow it.

charcircuit 4y ago

>And then that person could say that they hold $1M dollars You don't own $1M dollars, you own debt which is an asset. Considering you just bought it for $500k it sounds like the market price for that debt is $500k.