FASB-IASB Group Discusses Fair Value, Financial Stability

What better day than Friday the 13th for a group called the Financial Crisis Advisory Group (FCAG) to debate financial stability vs. transparency, fair value (mark-to-market) accounting, and dynamic vs. incurred loan loss provisions. FCAG, formed in December, 2008 as a joint advisory group of FASB and the IASB, is co-chaired by former SEC Commissioner Harvey Goldschmid, and Hans Hoogervorst, Chairman, AFM (the Netherlands Authority for the Financial Markets). Its members are mainly current and former regulators and some business and investor representatives.

Fair Value
FCAG members were asked whether further guidance on fair value (mark-to-market) was needed. Here are a few highlights of the discussion:

Former Comptroller of the Currency Gene Ludwig-observed, “One could say, ‘how can you be against fair value accounting, it’s fair?’” However, he added, “The issue before the house is not whether it’s fair value, but whether it should be driven by market value.” He continued, “I would put to you we’ve clearly - not just in the court of public opinion… at a time when markets don’t function, you can’t use market values to be equivalent to fair value, we have driven economic reality, we haven’t reflected economic reality.”

An FCAG member said, “An inquiry for the accounting profession, if one doesn’t get this right, it undercuts in the public’s mind the value of accounting. If we all had to sell our houses in 24 hours, the value we would get is de minimus; we have got to have a more robust view of what values are, what we have undercut is the voracity of [financial] statements.”

FASB Chairman Robert Herz, an observer at the meeting, said, “The standard [FAS 157, Fair Value Measurement] says ‘orderly sale,’ not a distressed sale.”

Ludwig commented, “Another way to conceptualize this, if you took mark-to-market to its extreme and said you have to value corporations on a mark-to-market basis, simply based on the market, you’d get very distorted valuations because of volatility; at a point in time, [prices can] dramatically change.”

Goldschmid said: “… I’ve never seen a CEO who didn’t believe there is light at the end of the tunnel…”
IASB Board member Jim Leisenring, an observer at the FCAG meeting, later said, “The light at the end of the tunnel might be the headlight on a train.”

Goldschmid said, “If I read the standard here [FAS 157] and the international standards correctly, there was much more room to take account of illiquid markets, distressed sales, than people were using; there was some naiveté out there, some idiosyncratic sale, [but] people [are] saying you have to take that.”

FASAC Chairman Dennis Chookaszian, also an observer at the meeting, added that the clarification issued by FASB (presumably referring to FSP 157-3, issued in Oct. 2008) “provides a clarification that gives you lots of flexibility, but it is not being used.” As to why it is not being used, he surmised, “It is difficult to come up with something credible, and you can’t ignore that fact that if you are a CFO or an accounting firm, you [may] get second guessed, when a year or two later the real numbers come out; even tough you believe it [at the time], you may not want to take that position… cannot ignore reality in the U.S. with substantial litigation risk; changing an accounting rule won’t do anything if people are concerned about that risk.”

Goldschmid asked Ludwig: “Are you arguing with 157 [FASB Statement No. 157, Fair Value Measurement] in the U.S.? Which parts? Category 3? Or [that] you take too long to get to Category 3?”

Ludwig replied, “Particularly when markets don’t function, but perhaps [as a] general rule, [one should] look at other [values], e.g. discounted cash flow, as a reflection of valuation of assets.”

An FCAG member said: “There is a difference between price and value; looking at markets [is looking at] price, not looking at value.”

Herz said, “That’s a broad discussion, but how far are we going to go?” He added, “I might support certain things for certain classes to use discounted cash flow, in fact [FAS] 157 tells you to do that.” He added, “Application in practice may be strained now because of market conditions, behavioral implications of auditors, preparers, to just find a price, but the standard doesn’t tell you to do that.” Rather, he said, “The question is: how far can you go in ignoring market price.”

Jerry Corrigan, former President of the Federal Reserve Bank of New York, (and now with Goldman Sachs) expressed his support for fair value accounting, and decried reports of ‘draconian’ calls for suspension of fair value. (FCAG co-chair Goldshmid observed that no one at FCAG had called for any such draconian measures.)

Goldschmid said, referencing FCAG’s January 20 meeting in London, and also referencing the SEC staff report to Congress published Dec. 30, 2008 on mark-to-market accounting, which was led by SEC’s (then-Deputy Chief Accountant, now-Acting Chief Accountant) Jim Kroeker: “I should emphasize what we concluded in London, and what Jim Kroeker concluded, that fair value accounting had nothing to do with ...[the financial crisis] Jim [Kroeker] looked at how many banks…” [NOTE: Marie Leone of CFO.com published a summary of FCAG's Jan. 20 meeting, held in London, here.]

Ludwig asked Kroeker (an observer at the FCAG meeting): “[Did you look at] banks or banking organizations, if you look at banks by charter, they are mostly hold-to-maturity; but by .... very large [portfolio] of trading assets [are] marked-to-market.”

Kroeker replied, “[We looked at] financial institutions, and found nonperforming loans seemed to be the primary issue at financial institutions, it wasn’t mark-to-market.”

Corrigan also questioned some of the statistics in the SEC’s report to Congress on mark-to-market accounting issued Dec. 30, 2008. He questioned in particular the relatively low proportion of assets marked-to-market as shown in the SEC study, and said, “I don’t think it is representative of the very large systemically important banking and universal banking groups; the incidence of the use of fair value I’m quite certain is a lot higher than the numbers that you would say for that relatively small but very important group of banks.”

Kroeker responded, “The study took the thirty largest financial institutions, so it is included in the population.”

Corrigan replied, “Those numbers just don’t sound right to me… I’ve looked at these numbers pretty carefully.”

Corrigan continued, “I don’t think it’s any surprise I say as a creature of my environment, I learned at Paul Volcker’s knee, historic, cost accounting, especially for loan type products, discounted cash flow, [was like] Moses coming down from the mountain, and now after 15 yrs at Goldman Sachs where I live and breath fair value for everything, I have a somewhat different view of who Moses is or was. In conclusion, I think watering down fair value is the wrong way to go, and if anything, [the] direction [should be], as suggested earlier, to find ways to improve it, and with those improvements in place, find ways to broaden its application.”

Goldschmid added, “Which would allow you to do a fair amount of simplification too.”

Other topics covered
Other topics covered at the Financial Crisis Advisory Group (FCAG) meeting included the mixed attribute model and loan loss provisioning. Read more highlights from the FCAG meeting here.

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FEI Financial Reporting Blog provides highlights from SEC, PCAOB, FASB, IASB, and other regulatory news, including reporting under Sarbanes-Oxley Sect 404. It is written by Edith Orenstein, Director of Technical Policy Analysis at FEI

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