Capital Markets

The Blame Game Goes into Overtime

The spotlight on fair-value accounting, and its alleged impact on the financial crisis, grows still brighter and hotter.
Marie Leone and Scott LeibsApril 1, 2009

The debate over the fairness and value of fair-value accounting intensified last month as lawmakers took accounting rule–setters to task for the role that fair value has allegedly played in the current economic crisis. In response, the Financial Accounting Standards Board moved with uncharacteristic speed to provide additional guidance on how financial institutions should value assets and liabilities, particularly those thinly traded or untraded assets that require a so-called Level 3 valuation method.

“This is an emergency situation that requires expeditious action, not academic treatises,” said Paul Kanjorski (D–Pa.), chairman of the House Financial Services subcommittee that grilled members of FASB and the Securities and Exchange Commission on the role that fair value may have played in causing banks to take huge write-downs on mortgages and other securities.

While FASB did propose new guidance for public comment just days later, at the congressional hearing both it and the SEC were careful to say that the rules themselves are not to blame. “Accounting did not cause this crisis and accounting will not end it,” said James Kroeker, the SEC’s acting chief accountant. “But accounting should not make it worse.”

The problem, according to FASB chairman Robert Herz, lies not with the rules themselves but with how companies interpret them. While current guidance for Level 3 assets states that valuations should be based on the prices assets would fetch if an orderly transaction were possible, versus forced or distressed (that is, fire-sale) prices, many companies have resisted practicing the kind of judgment that approach would require (fearing the auditor scrutiny it might invite), and instead have cast about for a last-transaction price. Often that results in the exact sort of fire-sale price that current rules advise against.

FASB has thus proposed new guidance that may take effect this month. It takes the form of two new staff positions, one that uses a two-step process to help asset holders determine whether “a market for a financial asset that historically was active is not active and whether a transaction is not distressed” and one that would provide guidance on how to account for securities losses on “other-than-temporary impairments.” If both proposals are approved, they would be effective for interim and annual periods ending after March 15, 2009.

Just days after lawmakers vented their ire on Capitol Hill, a meeting of the International Accounting Standards Board also turned rancorous over fair-value rule-making, but in the end it seemed likely that the IASB would use the proposed FASB guidance as a way to jump-start its own comment period — despite IASB board member James Leisenring’s objection that banks may well “organize a 5,000-bank comment letter that says, ‘Right-on, baby, our earnings will go up and we’ll have no more losses.’”