The Five Dumbest Things on Wall Street: Feb. 15

5. About That Mortgage Risk

Risk reassessments can be a real downer for accountants.

Take the famed auditing house PricewaterhouseCoopers, for instance.

Having signed on the dotted line at various credit crunch stars like MBIA for years, the firm appears to have had a sudden epiphany at insurance giant AIG (AIG).

Still reeling from past accounting scandals, AIG announced Monday it will be forced to write down the value of financial instruments tied to mortgages after PWC said it had found "material weakness" in its accounting systems.

Remember that pesky $1 billion loss the company announced late last year for the months of October and November? Well, let's make it a cool $4.9 billion instead and call it even. Oh, and as for December -- we'll have that for you in a few weeks -- should be a doozy.

Shares of AIG responded to the announcement by dropping almost 12% in one day. Suddenly, the company's previous statement that it had "little to no exposure" to asset-backed commercial paper, structured investment vehicles or collateralized debt obligations tied to residential mortgage-backed securities had little to no credibility.

In a regulatory filing, AIG said it has yet to determine the full extent of "the amount of the increase in the cumulative decline in fair value" of its super senior credit default swap portfolio. Usually, investments in a company's portfolio are valued using a "mark-to-market" approach, which requires auditors to use whatever valuation is given to an investment in the market at the time of the audit.

In the case of a complex derivative security, however, for which there is no liquid market, accountants are basically paid to make something up using some assumptions that few people really understand. Nowadays, many of the assumptions that have been long made on securities tied to the U.S. housing market are under review, so to speak.

On Tuesday, AIG said in a statement that it continues to believe that losses on super senior credit defaults swaps "are not indicative of the losses [AIG Financial Products Corp.] may realize over time."

Dumb-o-meter score: 68. Maybe this time, they'll be right. Just don't hold your breath.

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