Capital Markets

Some CFOs Spring to Fair Value’s Defense

B of A and Freddie Mac finance chiefs, in different arenas, support the control of risk that mark-to-market accounting provides.
Stephen Taub and Roy HarrisMay 15, 2008

In an environment filled with skepticism about fair-value accounting, two CFOs of large financial-services companies — Bank of America Corp. and Freddie Mac — are speaking up for the practice of marking assets to market.

Their support came in very different arenas.

Joe Price, B of A’s finance chief, spoke directly in support of fair-value accounting at a Federal Reserve Bank of Chicago conference on Thursday. While he said there was room to “re-examine and improve” the mark-to-market approach, he also stressed that fair value is a key component “of risk control for market-based businesses,” Reuters reported. Price was participating in a panel at the Conference on Bank Structure and Competition, which has a theme of “Credit Market Turmoil: Causes, Consequences and Cures.”

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Meanwhile, in reporting a smaller-than-expected first-quarter loss on Wednesday at Freddie Mac, CFO Buddy Piszel said that fair-value accounting changes were helping the government-sponsored mortgage lender expose investors to the actual underlying worth of its assets. In addition, the fair-value accounting change cut Freddie’s loss to $151 million from what would have been a loss of more than $2 billion.

Specifically, the accounting change led Freddie to reduce the value of net assets to a negative $5.1 billion on March 31, from a positive $12.6 billion at the end of the prior quarter, according to press reports. The costs of mortgage defaults were at the root of the plunge to negative ground, reflecting that assets have a lower estimated market value than the estimate value of its liabilities.

In an interview with the Wall Street Journal, Piszel said the negative fair value reflected distressed prices for mortgage securities, and had “no impact” on operations for long-term holders of mortgages, as Freddie Mac is. Some accounting changes at Freddie specifically reflect the value of the obligations for compensating those who invest in mortgage securities when the loans backing the securities default and result in losses.

Piszel also said that its regulator, the Office of Federal Housing Enterprise Oversight (Ofheo), was “aware of all of the accounting ahcnges and has taken no exception to them.”

Ofheo last week reduced the capital cushion that its two charges — Freddie Mac and Fannie Mae — resulting in a bid by Fannie to raise $6.5 billion in new capital to bolster the balance sheet. On Wednesday, Freddie said the move would allow Freddie to raise $5.5 billion in capital, through a split of common shares and preferred stock. However, CFO Piszel continued to caution that Freddie’s losses from bad mortgages and foreclosed properties would rise to at least $3.1 billion this year. “We would have to acknowledge that credit is worse,” he said in remarks quoted by the Associated Press.

In his talk to the Chicago Federal Reserve Bank, B of A’s Joe Price acknowledged that fair-value accounting will force many banks and investment firms to recognize huge losses related to the ongoing credit crunch. However, he added, “it is probably bringing to light some areas where the risk was underestimated, either in size or severity,” according to Reuters. Still, he said: “We would assert that changing the applicable accounting system will not address the more fundamental question related to risk assessment.”

Price’s remarks were somewhat surprising given that he operates in an industry quite negatively impacted by fair-value accounting principles, which have caused banks and brokerages to take multi-billion-dollar write-offs over the past year.

The B of A CFO also defended the concept of “principles-based” accounting, often championed overseas for the way it provides companies with more latitude for following broad accounting guidelines, rather than the rules-based U.S. approach.

Reuters noted that the six largest global accounting firms are pushing for worldwide adoption of International Financial Reporting Standards, which are generally more principles-based, a trend Price called positive.

He stressed, though, that it will be tough to move toward IFRS without reforms that would prevent lawyers from suing over specific rule violations, according to the report.