Excerpts from Fair-Value Accounting's "Atmosphere of Fear"
by David M. Katz
Senior finance executives at some of the biggest financial institutions are calling on the Financial Accounting Standards Board to reassess its new fair-value standards in light of the banks' experience in the subprime crisis.
The shift to fair-value accounting in the midst of the crisis spawned an "atmosphere of fear" that lead to a "lockdown" in the use of judgment in valuing securities, they said last week at a Standard & Poor's conference provocatively titled "Is it Time to Write Off Fair Value?"
...
One part of the controversial new mark-to-market standard, FAS No. 157, Fair Value Measurements, that needs a second look is a provision that says that market prices must be assessed on the basis of market participants that are "willing" to buy or sell the asset or liability but are not "forced or otherwise compelled to do so," according to Bob Traficanti, head of accounting policy and deputy controller of Citigroup.
Traficanti, a former FASB project manager who worked on FAS No. 133, the board's hedge-accounting standard, suggested that some of the prices that the bank had to come up with indeed felt coerced. One of the "unintended consequences" of the new rules has occurred at Citigroup "in situations where we have securities with little or no credit deterioration, and we're being forced to mark these down to values that we think are unrealistically low," he said. "I would ask the FASB to ... back-test to see how this really worked."
Similarly, Christopher Hayward, a Merrill Lynch senior vice president and finance director, asked FASB to go back and look at the results of the standard with an eye to the "almost borderline panic" that beset many companies at the prospect of gauging the fair value of securities with no semblance of a market. Many firms in the financial-services industry lacked the models to create hypothetical markets when the real ones dried up, he added.
But not only the financial firms were unprepared, Hayward said. Their auditors also found themselves fumbling in the dark. As result, the Merrill executive said, they advised their clients, "Let's just mark [an asset or liability] down; there's no question if we mark it down heavily."
The intense conservatism that ensued eclipsed the role of judgment in marking instruments to market, according to David Johnson, the outgoing CFO of the Hartford Financial Services Group. He called papers issued last fall by the Center for Audit Quality (CAQ), an offshoot of the American Institute of Certified Public Accountants, "basically a shoot-to-kill order for anyone who would exercise judgment."
Tuesday, July 1, 2008
07/01/2008: Are Bean Counters to Blame?
Excerpts from Are Bean Counters to Blame
by Andrew Ross Sorkin
[Stephen A. Schwarzman], the co-founder of the private equity giant Blackstone Group, has been espousing this view for weeks over lunches and at cocktail parties around the globe. It’s a controversial hypothesis, which others have put forward before, and it has sparked plenty of debate within the industry. But Mr. Schwarzman is convinced that the rule — known as FAS 157 — is forcing bookkeepers to overstate the problems at the nation’s largest banks. ... The president of Blackstone, Hamilton E. James, goes even further. FAS 157, he said, is not just misleading: “It’s dangerous.”
...
FAS 157 represents the so-called fair value rule put into effect by the Federal Accounting Standards Board, the bookkeeping rule makers. It requires that certain assets held by financial companies, including tricky investments linked to mortgages and other kinds of debt, be marked to market. In other words, you have to value the assets at the price you could get for them if you sold them right now on the open market.
The idea seems noble enough. The rule forces banks to mark to market, rather [than] to some theoretical price calculated by a computer — a system often derided as “mark to make-believe.” (Occasionally, for certain types of assets, the rule allows for using a model — and yes, the potential for manipulation too.)
But here’s the problem: Sometimes, there is no market — not for toxic investments like collateralized debt obligations, or C.D.O.’s, filled with subprime mortgages. No one will touch this stuff. And if there is no market, FAS 157 says, a bank must mark the investment’s value down, possibly all the way to zero.
...
Some analysts, even insiders, say banks like Citigroup and Lehman Brothers marked down some of their C.D.O. exposure by more than 50 percent when the underlying mortgages wrapped inside the C.D.O.’s may have only fallen 15 percent.
Bob Traficanti, head of accounting policy and deputy comptroller at Citigroup, said at a conference last month that the bank had “securities with little or no credit deterioration, and we’re being forced to mark these down to values that we think are unrealistically low.”
by Andrew Ross Sorkin
[Stephen A. Schwarzman], the co-founder of the private equity giant Blackstone Group, has been espousing this view for weeks over lunches and at cocktail parties around the globe. It’s a controversial hypothesis, which others have put forward before, and it has sparked plenty of debate within the industry. But Mr. Schwarzman is convinced that the rule — known as FAS 157 — is forcing bookkeepers to overstate the problems at the nation’s largest banks. ... The president of Blackstone, Hamilton E. James, goes even further. FAS 157, he said, is not just misleading: “It’s dangerous.”
...
FAS 157 represents the so-called fair value rule put into effect by the Federal Accounting Standards Board, the bookkeeping rule makers. It requires that certain assets held by financial companies, including tricky investments linked to mortgages and other kinds of debt, be marked to market. In other words, you have to value the assets at the price you could get for them if you sold them right now on the open market.
The idea seems noble enough. The rule forces banks to mark to market, rather [than] to some theoretical price calculated by a computer — a system often derided as “mark to make-believe.” (Occasionally, for certain types of assets, the rule allows for using a model — and yes, the potential for manipulation too.)
But here’s the problem: Sometimes, there is no market — not for toxic investments like collateralized debt obligations, or C.D.O.’s, filled with subprime mortgages. No one will touch this stuff. And if there is no market, FAS 157 says, a bank must mark the investment’s value down, possibly all the way to zero.
...
Some analysts, even insiders, say banks like Citigroup and Lehman Brothers marked down some of their C.D.O. exposure by more than 50 percent when the underlying mortgages wrapped inside the C.D.O.’s may have only fallen 15 percent.
Bob Traficanti, head of accounting policy and deputy comptroller at Citigroup, said at a conference last month that the bank had “securities with little or no credit deterioration, and we’re being forced to mark these down to values that we think are unrealistically low.”
Person/Entity Index
Under Construction
A
ABX, ABX.HE: (1, 2, 3, 4, 5)
AIG: (1)
Adrian, Tobias: (1)
B
Bank of England: (1)
Bank of Scotland: (1)
Berkshire Hathaway: (1)
Bernanke, Ben: (1, 2)
BIS: (1)
Bove, Richard: (1, 2)
Buffett, Warren: (1)
Burt, Sir Peter: (1)
C
Citigroup: (1)
CMSA: (1)
Crittenden, Gary: (1)
E
European Union (EU): (1, 2)
F
Fearnley, Stella: (1)
Financial Executives International (FEI): (1)
Forbes, Steve: (1)
Frank, Barney: (1)
G
Greenlaw, David: (1)
H
Hatzius, Jan: (1)
Herz, Robert: (1)
I
Institute of International Finance (IIF): (1)
International Monetary Fund (IMF): (1, 2)
K
Kashyap, Anil K: (1)
Kaufman, Henry: (1)
Kothari, Vinod: (1)
Kovacevich, Richard: (1)
L
Lagarde, Christine: (1)
M
M&T Bank: (1)
MacDonald, Linda A. : (1)
Mauldin, John: (1)
McCain, John: (1)
McCreevy, Charlie: (1)
Minyanville: (1)
O
Orenstein, Edith: (1)
P
Persaud, Avinash: (1)
Plantin, Guillaume: (1, 2, )
President's Working Group on Financial Markets: (1)
R
REIT Wrecks: (1)
Resch, Ed: (1)
Reynolds, Alan: (1)
Roberts, Paul Craig (1)
Roubini, Nouriel: (1, 2)
S
Sapra, Haresh: (1, 2)
SEC: (1, 2, 3)
Seeberg, Thomas: (1)
Shin, Hyun Song: (1, 2, 3, 4)
Starkie, Michael: (1, 2)
State Street: (1)
Sunder, Shyam: (1)
V
Volcker, Paul: (1, 2)
W
Whitman, Marty: (1)
Wilmers, Robert: (1)
Z
Zielke, Carsten: (1)
A
ABX, ABX.HE: (1, 2, 3, 4, 5)
AIG: (1)
Adrian, Tobias: (1)
B
Bank of England: (1)
Bank of Scotland: (1)
Berkshire Hathaway: (1)
Bernanke, Ben: (1, 2)
BIS: (1)
Bove, Richard: (1, 2)
Buffett, Warren: (1)
Burt, Sir Peter: (1)
C
Citigroup: (1)
CMSA: (1)
Crittenden, Gary: (1)
E
European Union (EU): (1, 2)
F
Fearnley, Stella: (1)
Financial Executives International (FEI): (1)
Forbes, Steve: (1)
Frank, Barney: (1)
G
Greenlaw, David: (1)
H
Hatzius, Jan: (1)
Herz, Robert: (1)
I
Institute of International Finance (IIF): (1)
International Monetary Fund (IMF): (1, 2)
K
Kashyap, Anil K: (1)
Kaufman, Henry: (1)
Kothari, Vinod: (1)
Kovacevich, Richard: (1)
L
Lagarde, Christine: (1)
M
M&T Bank: (1)
MacDonald, Linda A. : (1)
Mauldin, John: (1)
McCain, John: (1)
McCreevy, Charlie: (1)
Minyanville: (1)
O
Orenstein, Edith: (1)
P
Persaud, Avinash: (1)
Plantin, Guillaume: (1, 2, )
President's Working Group on Financial Markets: (1)
R
REIT Wrecks: (1)
Resch, Ed: (1)
Reynolds, Alan: (1)
Roberts, Paul Craig (1)
Roubini, Nouriel: (1, 2)
S
Sapra, Haresh: (1, 2)
SEC: (1, 2, 3)
Seeberg, Thomas: (1)
Shin, Hyun Song: (1, 2, 3, 4)
Starkie, Michael: (1, 2)
State Street: (1)
Sunder, Shyam: (1)
V
Volcker, Paul: (1, 2)
W
Whitman, Marty: (1)
Wilmers, Robert: (1)
Z
Zielke, Carsten: (1)
Regulatory/Policy Documents
AICPA
Measurements of fair value in illiquid (or less liquid) markets
Bank of England
Financial Stability Report, April 2008, Issue 23
BIS
BIS Quarterly Review: June 2008
FASB
Statement of Financial Accounting Standards No. 157: Fair Value Measurements
Statement of Financial Accounting Standards No. 159: The Fair Value Option for Financial Assets and Financial Liabilities
Understanding Fair Value
Financial Stability Forum (FSF)
Report of the Financial Stability Forum on Enhancing Market and Institutional Resilience, 7 April 2008 , prepared for the G7 meeting in April, 2008
G7
Statement of G-7 Finance Ministers And Central Bank Governors
Institute of International Finance
Interim Report of the IIF Committee on Market Best Practices
International Monetary Fund
The Recent Financial Turmoil—Initial Assessment, Policy Lessons, and Implications for Fund Surveillance
Global Financial Stability Report: Containing Systemic Risks and Restoring Financial Soundness, April 2008
President's Working Group on Financial Markets
Policy Statement To Improve Future State of Financial Markets
SEC
Sample Letter Sent to Public Companies on MD&A Disclosure Regarding the Application of SFAS 157 (Fair Value Measurements)
Senior Supervisors Group
Senior Supervisors Group Report to the FSF: Observations on Risk Management Practices during the Recent Market Turbulence, March 6, 2008
Senior Supervisors Group Report to the FSF: Leading Practice Disclosures for Selected Exposures, 4/11/2008
Measurements of fair value in illiquid (or less liquid) markets
Bank of England
Financial Stability Report, April 2008, Issue 23
BIS
BIS Quarterly Review: June 2008
FASB
Statement of Financial Accounting Standards No. 157: Fair Value Measurements
Statement of Financial Accounting Standards No. 159: The Fair Value Option for Financial Assets and Financial Liabilities
Understanding Fair Value
Financial Stability Forum (FSF)
Report of the Financial Stability Forum on Enhancing Market and Institutional Resilience, 7 April 2008 , prepared for the G7 meeting in April, 2008
G7
Statement of G-7 Finance Ministers And Central Bank Governors
Institute of International Finance
Interim Report of the IIF Committee on Market Best Practices
International Monetary Fund
The Recent Financial Turmoil—Initial Assessment, Policy Lessons, and Implications for Fund Surveillance
Global Financial Stability Report: Containing Systemic Risks and Restoring Financial Soundness, April 2008
President's Working Group on Financial Markets
Policy Statement To Improve Future State of Financial Markets
SEC
Sample Letter Sent to Public Companies on MD&A Disclosure Regarding the Application of SFAS 157 (Fair Value Measurements)
Senior Supervisors Group
Senior Supervisors Group Report to the FSF: Observations on Risk Management Practices during the Recent Market Turbulence, March 6, 2008
Senior Supervisors Group Report to the FSF: Leading Practice Disclosures for Selected Exposures, 4/11/2008
Academic Papers
Liquidity and Leverage, by Tobias Adrian and Hyun Song Shin
Leveraged Losses: Lessons from the Mortgage Market Meltdown, by David Greenlaw, Jan Hatzius, Anil K Kashyap, Hyun Song Shin
Fair Value Reporting Standards and Market Volatility, by Guillaume Plantin, Haresh Sapra, Hyun Song Shin
Marking to Market, Liquidity and Financial Stability, by Guillaume Plantin, Haresh Sapra, Hyun Song Shin,
Marking-to-Market: Panacea or Pandora's Box?, by Guillaume Plantin, Haresh Sapra, and Hyun Song Shin
Leveraged Losses: Lessons from the Mortgage Market Meltdown, by David Greenlaw, Jan Hatzius, Anil K Kashyap, Hyun Song Shin
Fair Value Reporting Standards and Market Volatility, by Guillaume Plantin, Haresh Sapra, Hyun Song Shin
Marking to Market, Liquidity and Financial Stability, by Guillaume Plantin, Haresh Sapra, Hyun Song Shin,
Marking-to-Market: Panacea or Pandora's Box?, by Guillaume Plantin, Haresh Sapra, and Hyun Song Shin
Publisher Index
American Banker
12/28/2008: Three part series on fair value accounting (Part 1, Part 2, Part 3)
03/24/2008: Fair Value: Few Fans, But Fewer Alternatives
03/28/2008: Viewpoint: Accounting Rules Making Things Worse?
03/31/2008: RMA Group to Study Fair-Value Model
04/01/2008: SEC Modifies Disclosures for New Fair-Value Standard
Barrons
03/31/2008: Being Watchful of Wachovia: Dick Bove on Wachovia and ABX.HE
Bloomberg
03/11/2008: Mark Mobius on mark-to-market accounting
04/01/2008: Dick Bove on ABX.HE
04/15/2008: Swaps tied to losses became 'Frankenstein's Monster"
CFO.com
03/11/2008: Don't Mark to Markit: The king of credit indices casts doubt on its own products
03/20/2008: Barney Frank: Create a "Risk" Post
05/19/2008: Fair-Value Accounting's "Atmosphere of Fear"
Euromoney
03/01/2008: Understanding the mark-to-market meltdown
Financial Times
03/06/2008: Vicious spiral haunts debt markets
03/13/2008: An unforgiving eye: Bankers cry foul over fair value accounting rules
03/13/2008: AIG urges rethink on 'fair value' accounting
03/17/2008: Editorial Comment: Time to renew the financial toolbox
03/19/2008: Act now to stop the markets' vicious circle
03/28/2008: SEC's new guidance to stop short of suspending 'fair value' rules
04/01/2008: SEC fails to douse debate over 'fair value'
04/02/2008: EU advisers back fair value change
04/10/2008: Subprime barometer spins awry
04/10/2008: Comment: This crisis demands that we act, but not overeact
05/11/2008: Gloves off on fair value
06/11/2008: Accounting rulemakers putting markets at risk
National Post
03/18/2008: The mark to market fiasco
New York Times
07/01/2008: Are Bean Counters to Blame?
Reuters
02/26/2008: Is fair value accounting really fair?
03/26/2008: Four largest US banks' outlooks slashed-Oppenheimer
Telegraph.co.uk
04/06/2008: Relax rules to avoid recession, warns Burt
Wall Street Journal
03/05/2008: Mark to Meltdown?
03/14/2008: SEC Aims to Let Firms Explain Crunch Thorns
04/17/2008: Hardest to value assets escalate
06/06/2008: SEC, Justice Scrutinize AIG on Swaps Accounting
12/28/2008: Three part series on fair value accounting (Part 1, Part 2, Part 3)
03/24/2008: Fair Value: Few Fans, But Fewer Alternatives
03/28/2008: Viewpoint: Accounting Rules Making Things Worse?
03/31/2008: RMA Group to Study Fair-Value Model
04/01/2008: SEC Modifies Disclosures for New Fair-Value Standard
Barrons
03/31/2008: Being Watchful of Wachovia: Dick Bove on Wachovia and ABX.HE
Bloomberg
03/11/2008: Mark Mobius on mark-to-market accounting
04/01/2008: Dick Bove on ABX.HE
04/15/2008: Swaps tied to losses became 'Frankenstein's Monster"
CFO.com
03/11/2008: Don't Mark to Markit: The king of credit indices casts doubt on its own products
03/20/2008: Barney Frank: Create a "Risk" Post
05/19/2008: Fair-Value Accounting's "Atmosphere of Fear"
Euromoney
03/01/2008: Understanding the mark-to-market meltdown
Financial Times
03/06/2008: Vicious spiral haunts debt markets
03/13/2008: An unforgiving eye: Bankers cry foul over fair value accounting rules
03/13/2008: AIG urges rethink on 'fair value' accounting
03/17/2008: Editorial Comment: Time to renew the financial toolbox
03/19/2008: Act now to stop the markets' vicious circle
03/28/2008: SEC's new guidance to stop short of suspending 'fair value' rules
04/01/2008: SEC fails to douse debate over 'fair value'
04/02/2008: EU advisers back fair value change
04/10/2008: Subprime barometer spins awry
04/10/2008: Comment: This crisis demands that we act, but not overeact
05/11/2008: Gloves off on fair value
06/11/2008: Accounting rulemakers putting markets at risk
National Post
03/18/2008: The mark to market fiasco
New York Times
07/01/2008: Are Bean Counters to Blame?
Reuters
02/26/2008: Is fair value accounting really fair?
03/26/2008: Four largest US banks' outlooks slashed-Oppenheimer
Telegraph.co.uk
04/06/2008: Relax rules to avoid recession, warns Burt
Wall Street Journal
03/05/2008: Mark to Meltdown?
03/14/2008: SEC Aims to Let Firms Explain Crunch Thorns
04/17/2008: Hardest to value assets escalate
06/06/2008: SEC, Justice Scrutinize AIG on Swaps Accounting
Wednesday, June 11, 2008
6/11/2008: Accounting rule-makers putting markets at risk
Excerpt from Accounting rule-makers putting markets at risk
By Michael Starkie, chief accountant at BP for the past 14 years and for some years chairman of the UK's CBI Financial Reporting Panel and a member of the European Financial Reporting Advisory Group (EFRAG) Technical Expert Group
By Michael Starkie, chief accountant at BP for the past 14 years and for some years chairman of the UK's CBI Financial Reporting Panel and a member of the European Financial Reporting Advisory Group (EFRAG) Technical Expert Group
- [T]he future looks even bleaker. The International Accounting Standards Board continues to develop an accounting model about which users of financial information have grave misgivings. Probably the most disturbing example is the use of predominantly mark-to-model exit values in the balance sheet, which cannot be relevant for a market trying to assess the economic performance and position of companies that have the intention of continuing to operate as going concerns.
- Mr Starkie’s views also reflect a long-running concern among many accountants and investors about the focus of some IASB members on developing a coherent theoretical accounting framework without due regard for business practicalities. The danger, they fear, is that if accounting becomes less reflective of companies’ operations, investors could lose trust in published accounts, which would raise the cost of capital for companies and upset financial markets.
This has come to the fore in the ongoing fight over “fair value” accounting, where assets and liabilities are reported at their current market price. While most accept this for frequently-traded financial instruments, there are fears that some IASB members want to extend the concept to assets for which there are no markets, potentially forcing companies to produce hypothetical values.
“Ironically, that would introduce a degree of guesstimation into financial numbers that if it were companies who called for it, they’d get howled down with derision for wanting to fix the numbers,” said Mr Starkie in an interview with the FT. The IASB has said it has no intention of extending the practice.
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