Tuesday, April 24, 2007

Using Fuzzy Math to Calculate What is Fair

Didn’t fuzzy math go the way of the crooked “E”? Back when the smartest boys in the room were booking unbelievable profits, Enron relied on what is referred to as “fair value” accounting. Spring is here and it seems that Blackstone thinks that practice is back in vogue. A recent piece from the WSJ highlights how Blackstone plans to adopt this accounting practice once it becomes a public company. Fair value accounting would give Blackstone full discretion in deciding what its investments are worth and consequently, what performance and management fee revenue it can book in interim periods. The problem with this practice is that most of those investments are very illiquid and coming up with some fair market value can quickly become an exercise in subjective self-affirmation. “Good job Mortimer! Good job Randolph!”

How many of us couldn’t have used a “fair grade” system in college. Imagine it, our professors would have trusted us, and let us give ourselves a mid-term grade based on how we thought we’d do on the final exam at the end of the semester. So much for being merit-based. This is the same concept, except with dollar signs and IRR figures instead of a GPA. According to the WSJ, even accounting experts express doubt that Blackstone’s intentions are sound. All of this should remind us of the KISS principal. Earning an honest buck shouldn’t be so complicated. Or is that being too naïve? Is it the machinations that allows one to make a buck in today’s world? What would we call this, “Smarts Arbitrage” or “Hired Gun Arbitrage”? I guess the rest of us should have studied harder for those mid-terms . . . or stumbled upon fuzzy math sooner.

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