ABA Levels New Blast at Fair Value

The bank lobbying group tells the SEC that marking an asset to an illiquid market does not show its true value.
Alan RappeportSeptember 24, 2008

The American Bankers Association is telling the Securities and Exchange Commission that fair value accounting rules are flawed because they don’t describe how to accurately determine the value of an asset in a distressed market.

In a letter sent on Tuesday, the bank lobbying group took aim at FAS 157, which governs fair value. The ABA claims that the accounting standard fails to explain what to do when “sellers are not selling and typical buyers are not buying in meaningful volumes.” Fair value, or mark-to-market, accounting determines the value of an asset based on what price it can fetch on a market. Because the market for mortgage-related assets is largely frozen, critics such as the ABA contend that fair value does not reflect an asset’s intrinsic value.

“Many holders of assets are restrained from selling, because they know the economic values of their assets are greater than the distressed sale values they are seeing in the marketplace,” wrote Edward Yingling, president and CEO of the ABA, in the letter, addressed to SEC Chairman Christopher Cox.

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The ABA requested that the commission give guidance saying that intrinsic or economic value are “appropriate proxies” for fair value. Yingling suggested that companies should look to cash flows rather than fair value, since only holders of assets that are forced to sell are doing so in the current market conditions. “Why would the accounting literature require the use of a non-functioning market value?” Yingling asked.

Going forward, the ABA also suggested that future accounting rules or amendments that are based on fair value principles be reconsidered. Yingling recommended a “temporary stay” on the creation of new accounting standards until the role of fair value is assessed. John Snowling, an ABA spokesman, told that the group was trying to organize a meeting with the SEC for sometime this week.

The SEC had no comment on the letter, although commission spokesman John Nester noted that on Cox on Tuesday had told members of the Senate Banking Committee that regulators and standard setters were working on timely guidance.

Fair value accounting has faced mounting criticism from banks lately, as asset prices have fallen. At Tuesday’s congressional hearing, Federal Reserve Chairman Ben Bernanke said that the need to mark assets at “fire sale” prices had created a vicious circle, while noting that eliminating the practice could be harmful.

“A fire sale price is not fair value,” said Cindy Ma, a managing director of Houlihan Lokey, who runs the investment bank’s illiquid and complex securities valuation practice. “The challenge is to establish a reasonable ‘hold-to-maturity price.’”

The Fed’s Bernanke mentioned the hold-to-maturity price at Tuesday’s Senate Banking Committee hearing as a price that might be a reasonable target for buying illiquid securities. But Ma said that the term still is subject to interpretation by market participants. A potential balanced approach, she said, will be using valuation assumptions reflecting the fair value of assets sold in an orderly market.