If your assets are worth less than your liabilities, you're technically insolven... (2024)

mikeyouse on July 17, 2014 | parent | context | favorite | on: Large Round of Layoffs Expected at Microsoft

If your assets are worth less than your liabilities, you're technically insolvent. If you can still pay your bills from cashflows, you don't need to claim bankruptcy, but on a long enough timeline without a significant change, you will go bankrupt. There was a long stretch of time post-GFC where this was the case with GE.

Banks have to 'mark-to-market' their debt periodically, but since GE wasn't a bank, they didn't abide by the same regulations. Say there were two identical houses on a street with $500k mortgages, but the market crashed, the houses are worth less, and only 1/2 of the mortgages will be repaid. If Bank of America owned the first house, the mortgage asset (it's an asset to the bank) would be marked-to-market and what was formerly a $500k asset would now be worth $250k, and the bank would show a loss of $250k.

GE doesn't have to do this and could carry assets at their previous value (and didn't have to mark down bad debt either). To simplify the story, during the GFC, GE had that one mortgage "worth" $500k and debts worth $400k. If they were a bank, they would have had to admit that the mortgage was really worth $250k, and they would've gone into receivership.

If not for that accounting quirk and the massive amount of bailout cash they took from the Federal Reserve / FDIC, they would have actually had to declare bankruptcy. Ironically enough, the FDIC program and Federal Reserve are to shore up banks and GE was explicitly not a bank per the above few paragraphs. So make sense of how they got access to bailout money solely authorized to bail out banks..

[1] - $45B in losses buried on GE's balance sheet: http://www.businessinsider.com/henry-blodget-living-on-plane...

[2] - GE borrowed $16B from Federal Reserve: http://www.propublica.org/article/general-electric-tapped-fe...

[3] - FDIC to back $139B in GE Capital Debt: http://dealbook.nytimes.com/2008/11/12/fdic-to-back-139-bill...

[4] - GE Borrows $59.3B from FDIC program: http://www.bloomberg.com/news/2010-12-01/ge-borrowed-16-bill...

If your assets are worth less than your liabilities, you're technically insolven... (2)

clarky07 on July 17, 2014 | next [–]

> If your assets are worth less than your liabilities, you're technically insolvent.

No you aren't. It just means you have a negative net worth.

insolvent - unable to pay debts owed.

Think of people instead of companies. I suspect a majority of people in America have a negative net worth. That doesn't make them insolvent. It just means they have lots of college loans and they are working to pay them back.

If your assets are worth less than your liabilities, you're technically insolven... (3)

barrkel on July 17, 2014 | parent | next [–]

http://www.investopedia.com/terms/a/accounting_insolvency.as...

A situation where the value of a company's liabilities exceeds its assets. Accounting insolvency looks only at the firm's balance sheet, deeming a company "insolvent on the books" when its net worth appears negative.

If your assets are worth less than your liabilities, you're technically insolven... (4)

clarky07 on July 17, 2014 | root | parent | next [–]

you added an adjective to the term :-) Yes you can call them insolvent if you want to, but it doesn't mean anything if they can still pay their debts. If the number keeps going down it is certainly a problem, but if it heading back up it is fine.

The housing crisis is a perfect example of this. It only became a problem for people who bought more house than they could afford with hopes of selling at a moments notice. My house was as much as 50k underwater (going based on foreclosure sales of identical townhouses) during the crisis. Fortunately, I didn't buy more house than I could afford. I could easily continue to pay my mortgage each month and was never anywhere near bankrupt. I sold the house recently for closer to 10k loss. Was I insolvent when the house was down 50k? No.

[1]Cash flow insolvency involves a lack of liquidity to pay debts as they fall due. Balance sheet insolvency involves having negative net assets—where liabilities exceed assets. Insolvency is not a synonym for bankruptcy, which is a determination of insolvency made by a court of law with resulting legal orders intended to resolve the insolvency.

[1] http://en.wikipedia.org/wiki/Insolvency

If your assets are worth less than your liabilities, you're technically insolven... (5)

mikeyouse on July 17, 2014 | root | parent | next [–]

The quote of mine that you first replied to was:

> If your assets are worth less than your liabilities, you're technically insolvent.

Which you disagreed with. It's a literal, factual statement though.

> Yes you can call them insolvent if you want to, but it doesn't mean anything if they can still pay their debts.

It actually does mean something in corporate finance.

> Was I insolvent when the house was down 50k? No.

Stop comparing corporate finance to personal finance, they aren't remotely similar. The only reason that the phrase "Technical Insolvency" exists is because there are consequences if companies breach that threshold.

From the Title 11 of the US Bankruptcy Code[1]:

 The term “insolvent” means— (A) with reference to an entity other than a partnership and a municipality, financial condition such that the sum of such entity’s debts is greater than all of such entity’s property, at a fair valuation

This isn't just parsing terms for fun, contract law relies on US Federal code, which has definite consequences for insolvency. All commercial loans come with a plethora of 'loan covenants' that mandate certain actions based on a company's health. Common covenants include coverage ratios, debt/equity ratios, times-interest earned ratios, etc. Technical insolvency would've breached many, many covenants.

If a loan covenant is breached, the debt-holder can demand additional collateral and in some cases, they can demand full repayment of their outstanding debt. At the time, GE had ~$90B in cash/investments and over $300B in current debt. A fire-sale on those assets to pay off that debt load would have killed GE.

[1] - http://www.law.cornell.edu/uscode/text/11/101

If your assets are worth less than your liabilities, you're technically insolven... (6)

mikeyouse on July 17, 2014 | parent | prev | next [–]

Barrkel's got it right. At least in accounting terms, companies aren't people and your college loans don't have covenants that allow the debtholder to liquidate assets.

The world of corporate accounting is very literal. 'Technical insolvency' is a synonym for balance sheet insolvency, while the inability to pay a debt is 'cash-flow insolvency'. You can have either type, both, or neither depending on circ*mstances.

GE at the time would've still been cash-flow solvent, however they had tens of billions of dollars in debt coming due that likely would've forced them into cash-flow insolvency without taxpayer money.

If your assets are worth less than your liabilities, you're technically insolven... (7)

r00fus on July 17, 2014 | prev [–]

Also to note: our megabanks would also likely be forced into restructuring (it's probably a bad idea for a bank to go bankrupt) if they also had to "mark to market" with the same strictness as before.

Instead of restructuring, the Fed and FASB decided to blow more bubbles in 2009:

http://www.marketwatch.com/story/fasb-approves-more-mark-mar...

If your assets are worth less than your liabilities, you're technically insolven... (8)