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ANALYSIS
March 2, 2009
Sagging Index no longer reflects what’s going on in the market, some say, Replacements? Google it, to start.
March 2, 2009
Downward price spiral will actually boost the cost of capital for most companies. CFOS, take note.
March 2, 2009
The latest bailout at AIG could be a preview of how the president will deal with Wall Street.
March 2, 2009
No corporate defaults. Big debt offerings. Percolating CP issuance. Things may be looking up in the capital markets.
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October 5, 2008 12:01 AM ET
The backlash against fair-value accounting standards found its way into the $700 billion bank bailout bill signed by President Bush last week. Provisions instruct the Securities and Exchange Commission to study whether mark-to-market rules governing valuations of distressed assets have exacerbated Wall Street’s woes—and reaffirm the agency’s explicit authority to suspend the rules if deemed necessary. Supporters of fair-value accounting say the provision could lead the SEC to roll back years of improvements in financial reporting, and in the process cause investors to suspect that banks saddled with bad mortgage securities are hiding their losses. The controversy isn’t likely to die down soon, given the ambiguity in the bill’s language. It states that the SEC has the authority under the Securities Exchange Act of 1934 to suspend the application of Financial Accounting Standard 157, the Finan-cial Accounting Standards Board’s fair-value standard, “if the SEC determines it is necessary or appropriate in the public interest and is consistent with the protection of investors.” Much depends on what the SEC would allow banks to do instead. The bill talks of suspending both mark-to-market accounting and FAS 157. But FAS 157 already allows for alternatives, as the SEC and FASB saw fit to remind companies in a “clarification” the agencies released last week after the provision was included in the bill. In fact, the clarification stated, assets needn’t be marked strictly to market using actual prices, an approach under which assets in financial statements are labeled as level one. Instead, if there are no market prices available or if prices are deemed “distressed” or “fire sale,” assets can be marked to theoretical models based on expected cash flows under other market conditions, an approach known as level three. The rule also allows companies to value assets using some combination of actual and theoretical prices, under the designation level two, although there’s some dispute among accounting experts as to whether actual prices must be used along with model prices if the market prices are considered “fire sale.” If the SEC merely suspended requiring the use of actual market prices of any kind, companies presumably could reclassify all assets now designated level one or two as level three instead, and mark them up to the higher prices that their theoretical models could provide. If, on the other hand, the SEC suspended FAS 157 entirely, companies would still have to mark the assets to market, because the previous rule allowed them to carry such assets at historical cost only if they haven’t been impaired, which of course they have been with the collapse of housing prices. In that case, they’d have to be marked to market anyway. “If you end fair value, then you go back to a prior system of lower of cost or market,” noted David Larsen, managing director at Duff & Phelps. “You still end up at the same place.” Other observers envision a third scenario in which the banks could carry impaired assets at historical cost, which would not reflect the recent effect of plummeting home prices. Which course is the SEC likely to pursue? The commission declined to comment. But the Financial Accounting Foundation, which oversees FASB, wrote a letter to Congress last Thursday expressing concern that efforts to legislate the suspension of fair value would undermine the integrity and independence of the standards-setting process. A spokesman for FASB told Financial Week that the question of what type of accounting would be required instead of mark-to-market is up to the SEC to decide. Without a clear answer as to what would replace mark-to-market, some observers doubt the SEC will do much of anything. “It would weaken investor confidence in our capital markets,” said Jeff Mahoney, general counsel at the Council of Institutional Investors. So why did the bill specify that the SEC had the authority to suspend fair value? “It’s politics,” said Mr. Larsen of Duff & Phelps. “Accounting standards have be-come a scapegoat for poor decisions.” CCI’s Mr. Mahoney contended that the provision was added to the bailout bill at the behest of bank lobbyists such as the American Bankers Association. He said that the lobbyists initially sought to have the bill itself suspend the standard, but that the Treasury balked. The ABA and other organizations such as the Financial Services Roundtable counter that fair value has exacerbated the effects of the current credit crisis for banks by creating a vicious cycle in which asset markdowns lead to stock sell-offs that, in turn, lead to more markdowns. “We’re trying to have the application of the standard [on fair-value accounting] accurately reflect the true value of the assets,” said Jonathan Snowling, a spokesman for the ABA. Indeed, the ABA said last week it welcomed the clarification from FASB and the SEC confirming that companies can use internal assumptions such as future cash flow when determining fair value in an illiquid market. But Mr. Mahoney said the clarification was merely a confirmation of the existing standard. He suggested the ABA wants to replace fair value with a looser approach to tallying historical costs. “I wouldn’t interpret what they’re saying as relying on level three,” he said of the ABA’s position. “I would interpret it as [wanting] a calculated number that doesn’t refer to fair value [and] has no economic meaning.” Other supporters of fair value say even the level three designation is subject to abuse. “The models have [been] shown not to be accurate,” said Maureen O’Hara, professor of finance at the Johnson Graduate School of Management at Cornell University. “That’s not the solution. You have to supplement it with the market.” Mr. Mahoney warns that if fair value is suspended, the U.S. banking system could end up like Japanese banks in the 1990s, after the government there asked financial institutions not to write down instruments to market value. That only dragged out the country’s recession, because the banks were never recapitalized and returned to a position to lend. Suspending fair value here could also discourage healthy banks from purchasing struggling ones, as some observers say is necessary to help recapitalize the system. “You get in a lot of trouble when you start putting fictitious numbers on value,” billionaire investor Warren Buffett explained last week in an interview with PBS talk show host Charlie Rose. FW
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