The passage of the financial rescue plan by Congress last week depended in part on the insertion of a provision on reevaluating the fair value accounting standards, which could come back to bite the same lobbyists who urged its inclusion.
In recent weeks there has been a renewed push to suspend the rules on mark-to-market, or fair value, accounting by groups such as the American Bankers Association and the Financial Services Roundtable. They claim that the fair value standards are causing financial firms to continually lower the value of assets such as mortgage-backed securities for which there is no market, driving them down further and further.
The Securities and Exchange Commission and the Financial Accounting Standards Board provided interpretive guidance last week that allows management to use internal assumptions about expected cash flows, and inputs such as broker quotes, to measure fair value when the relevant market evidence does not exist. The bailout bill also reaffirmed the SEC’s power to suspend mark-to-market accounting and authorized the SEC to conduct a study on the effects of mark-to-market accounting standards, to be delivered within 90 days.
A suspension of fair value accounting standards would no doubt improve the balance sheets of financial institutions that are stuck with assets they can’t sell to one another. Such a suspension would also come at a convenient time as the Treasury prepares to buy up those assets with the $700 billion or so authorized by the bill. Finding a valuation for these seemingly worthless assets has proven to be a thorny problem for banks and financial firms. Giving them the ability to set a value based on their held-to-maturity assumptions would allow them to pump up the value and make a tidy profit when the securities are sold off to taxpayers.
However much improvement they provide to the financials of the banks, the suspension of fair value accounting for these difficult-to-price assets will likely lead to further suspicions about the underlying value of other assets held by the banks. Wall Street already has a confidence problem. If investors lose all confidence in any of the asset valuations provided by the banks, share prices will be pummeled even further.
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