Editor's Note: The debate over mark-to-market rules could result in major changes for financial companies such as Citigroup, AIG, Bank of America, Wells Fargo, Goldman Sachs, JPMorgan Chase and many others. We welcome a variety of opinions about how this should be addressed. To submit an opinion, please click here to send an email to the editor.
By Cindy Fornelli, executive director of the Center for Audit Quality.
Some points are beyond dispute in the debate over fair value accounting standards. We can all agree that our economy is in crisis and that our financial institutions are under strain.
But claims that fair value (or mark-to-market) accounting is the root cause of the current economic climate are misguided.
Fair value is a measuring tool designed to reflect reality, not create it. Suggesting it is responsible for our economic woes is like blaming a thermometer for cold weather. In fact, the
Securities and Exchange Commission's
report to Congress last December concluded that the crisis was precipitated by what it characterized as a "run on the bank" at certain financial institutions, not by fair value accounting.
Sacrificing transparency for investors by suspending fair value would not cure the problems in the financial system, it would only mask them. And in recommending that Statement of Financial Accounting Standards No. 157 (FAS 157) should be improved, but not suspended, the SEC said it is important "to clearly demarcate the difference between the accounting standards that require measurement of financial instruments at fair value (as required by the U.S. Generally Applied Accounting Principles) and (FAS 157), which only provides guidance on how to estimate fair value." In other words, a suspension of FAS 157 would not remove the requirement to account for assets or liabilities at fair value.
It's worth noting that fair value accounting has served us well for three decades. The importance of market-based standards became painfully apparent during the savings and loan crisis in the 1980s. That industry's reluctance to directly confront its overexposure to bad real estate loans extended the length and severity of the crisis, and added to the cost of the government clean-up.
The concept of fair value accounting has become widely accepted since then. It is intuitively obvious that what you paid for an item in the past doesn't matter nearly so much to an investor as what you could sell it for right now. Investors need to know the current value of assets so they can make fact-based decisions about whether to buy, sell or hold investments. That's what fair value is designed to provide.
By bolstering investor confidence in the reliability of audited financial statements, fair value accounting adds to the strength and stability of the capital markets. Suspending fair value accounting would remove valuable information from the marketplace - and at a time when we need it more than ever.
Requiring businesses to acknowledge the decline in asset values as they occur combats the natural tendency to put off dealing with tough problems in hopes they will somehow fix themselves. As we saw in the savings and loan debacle, allowing problems to fester can lead to further deterioration and even greater shocks to the system when the day of reckoning finally comes.
It is not surprising that some financial industry leaders want to see fair value suspended. At first glance, it seems like an easy fix for their problems. In reality, it is not a solution at all, and would unfairly penalize institutions that have made the tough decision to deal with severely distressed assets.
Anyone who has looked at their 401(k) lately knows that facing reality in today's economy can be painful. But we can't just pretend that the bad news doesn't exist. And we shouldn't abandon sound accounting standards and transparency on the false assumption that will help us address the scarcity of credit.
There may be ways to improve fair value methodologies, and we would welcome that discussion. But there should be no dispute about the value of transparency. Our financial system demands it. Investors deserve it.
Cindy Fornelli is executive director of the Center for Audit Quality, a Washington-based public policy organization serving investors, public company auditors and the markets. For more information, visit