Is Fair Value to Blame?

Lately, it seems like the concepts of fair value measurement and mark-to-market accounting have been taking a lot of blame in the hand-wringing over what is causing the fallout in the credit and mortgage securities markets.

Last month insurance giant American International Group and its CEO Martin Sullivan urged regulators to rethink the mark-to-market rules that force companies into showing losses on assets even when they have no intention of selling them at money-losing prices.

Sullivan wasn’t alone in urging changes. Bankers too have been voicing concern. Last week the American Bankers Association and the International Banking Federation also called on the Financial Accounting Standards Board and the International Accounting Standards Board to hold off on their proposals for full fair value accounting standards for financial instruments.

Even the presidential candidates are getting into the act. Sen. John McCain, R-Ariz., has called for a review of mark-to-market accounting rules and said they may be exacerbating the credit crunch.

At a press conference last week held by the CFA Institute for Financial Market Integrity, some of these questions came into sharp relief. The session included a panel of financial experts from the CFA Institute, FASB, Calcine Management and Carlson Capital (see Fair Value Accounting Challenged). The panelists had a variety of perspectives about the role of fair value measurement and mark-to-market, but they generally seemed to agree that going back to the old way of doing things based on historical cost just isn’t going to work anymore.

That’s especially true in today’s environment, where each day seems to bring news of another dramatic write-down or earnings miss that spooks investors and leads to further drops in value on once highly valued securities.

Clearly there need to be better solutions for valuing securities and assets than the present ones in today’s uncertain market. Hopefully they won’t lead to assets being unnecessarily devalued and spiraling quickly downward, but that trend may be difficult to reverse.

Still, there’s a lot to be said for taking a realistic look at overvalued assets, making the grim assessment, taking the write-down, and trying to avoid further pain and uncertainty down the road. Unfortunately today’s market is such an uncertain one that inevitably there will be further rude shocks ahead until the economy starts to recover. Accountants are going to require further guidance from regulators and standards bodies on valuing securitized assets, and for now fair value seems like the most realistic bet.