3/7/2008: Fair Value Accounting and Subprime

Excerpt from Fair Value Accounting and Subprime
By Michael Young, a member of the Financial Accounting Standards Advisory Council, which serves as the principal advisory council to FASB

What to do? Come up with the best possible models under Level 3 as the circumstances would allow. But this was no easy feat. Models valuing subprime investments might conceivably want to take into account such imponderables as the future of housing prices, the future of interest rates, and how homeowners could be expected to react to such things. One way or another, well meaning preparers found a way to come up with their best estimates and report them to investors. Not all investors seemed to appreciate, though, the extent to which the reported declines in value, presented numerically and thereby suggesting a level of precision that numerical presentation often implies, were necessarily based upon financial models that relied upon predictions about an inherently unknowable future. ... To some, particularly to those who never liked fair value accounting to begin with, this was all evidence that fair value accounting is a folly. ... But defenders of fair value accounting would point out that keeping financial assets on the books at levels well above that for which they could be sold is not exactly a model of transparency in accounting. ... Whatever one thinks of fair value accounting, though, one feature of the subprime aftermath has the potential to be completely counterproductive. It is the extent to which our system of litigation and regulatory oversight results in unjustified assertions of "fraud" against those who were doing their best under circumstances that were extremely difficult.