Friday, October 3, 2008

The Politics of Fair Value

The Economist previously published an excellent article on mark to market issues. This week they jumped in again with a rundown on how politics may affect accounting rules. here is their article followed by other excellent reading on the subject of fair value/mark to market.

Fair cop: Fair-value accounting becomes a political issue
IN FIRING their bazookas at the crisis, policymakers have blown holes in rules on everything from share trading to competition policy. It is therefore a miracle that fair-value accounting standards have not been hit too, in particular the requirement that banks “mark-to-market” most of their financial assets other than loans. These rules are deeply unpopular with many firms that have suffered losses and impaired capital positions. They would prefer to recognise losses in the traditional way—that is, slowly and when it suits them. More controversially, some argue the rules have created a vicious cycle of forced sales and falling prices.

The situation is more complex in Europe and other territories governed by the International Accounting Standards Board (IASB). The SEC is answerable to Congress, but there is no easy legal mechanism by which to turn up the heat on IASB, which is a private body. That has not stopped politicians from trying; Nicolas Sarkozy, the French president, reportedly sent a proposal to the European Commission that recommends suspending fair value, which he argues leaves bank balance-sheets “at the whim of speculators”. The commission may be receptive—Sir David Tweedie, IASB’s chairman, says that it mandated the use of international standards in Europe “with great courage and in total ignorance of the effects of its decision”.

Is it the beginning of the end for fair value? That seems unlikely. Standards setters will resist anything beyond tinkering with the rules. They will be supported by institutional investors and accounting firms. And anyway it now seems unlikely that suspending fair value would make much difference. The credit crunch has moved on, in the words of one banker, “from a mark-to-market phase to a more traditional phase of credit losses”. The recent forced sale of Wachovia, America’s fourth-largest commercial lender, reflected concerns about its loans, which banks almost always carry using historic-cost rules, not fair value. If mark-to-market accounting really does react too fast to the market, politicians may have responded too late.

Have We Learned Nothing?
Post-Enron regulations were supposed to hold companies and markets accountable. Author Bethany McLean explains what went wrong—again.
Eight years after the Enron debacle, Wall Street was supposed to have learned its lesson about creative accounting, excessive risk-taking and corporate greed. Government regulators and ratings agencies were supposed to be chastened, too. Instead, the rules never really changed, and we are now facing far deeper crises, according to financial author Bethany McLean. What's worse, she says, is that regulators are now encouraging accounting practices similar to those that contributed to Enron's fall.

NEWSWEEK: Congressional leaders say the bailout bill the Senate passed has more transparency about how the industry will spend taxpayers' $700 billion. But at the same time, it appears the government may be acting to reduce transparency, by banning short-selling and relaxing some accounting rules regarding how banks value their mortgage assets. It seems " Alice in Wonderland " -like.Bethany McLean: I think it's exactly "Alice in Wonderland." The notion that short sellers are to blame: it's a total reversal of cause and effect. They short a stock because they suspect the company is unsound—they do not cause the company to be unsound. Show me the gun that short sellers held to Wall Street executives that made them buy bad mortgages. And there's probably an argument to be made that the [Dow’s 777.68-point] decline would have been less if short sellers had been in the market because they step in and buy stocks when they cover their short positions.

Sarkozy seeks more flexibility on accounting rules
The pressure on regulators and rulemakers to ease "fair value" accounting standards in an effort to help end the financial crisis has been intensified by politicians. Nicolas Sarkozy, French president, is to urge his European counterparts this week to back changes that would introduce more flexibility in the accounting rules, while David Cameron, leader of the British opposition, yesterday said the rules had made the crisis worse and needed to be addressed.

Mr Sarkozy is seeking to give political momentum to EU efforts to tighten financial market rules after France became yesterday the latest European government to use public money - €3bn ($4.21bn, £2.37bn) of it - to bail out Dexia, the Belgian-French banking group. The president called a "crisis meeting" of French banks and insurers to discuss the financial turmoil.

In Defense of FAS 157
With the appropriate risk adjustments and illiquidity adjustments being made as instruments are purchased, the rescue plan can safeguard the government’s (and taxpayer’s) interest, while insuring the stability of the financial system. All of this doesn’t require rescinding FAS 157.

1 comment:

Stocks said...

Sarbanes Oxley was supposed to stop future Enrons from happening while increasing transparency of reporting. However, as you point out, there is still a long way to go in stopping the leaders of these large institutions from making risky financial decisions based solely on greed - the current Mortgage crisis as a good example. The main problem as I see it, is that both political parties are so intertwined with these large corporations (both Freddie May and Fannie Mac are controlled by Democrats and funneled campaign funds into Obama's campaign account) that in order to have true reform of the financial markets, we need to better regulate Corporate donations and Campaign reform. Until this happens, you will continue to see large corporations take advantage of the system where a few individuals benifit, while the majority of people get screwed.