Former SEC Chair Levitt Calls for Expanded Fair Value Accounting as Part of Overall Reform

Anticipating massive regulatory reform of financial market oversight, former SEC Chair Arthur Levitt called for the expansion of fair-value accounting to cover all of the financial instruments, the securities positions and loan commitments, of all financial institutions. In testimony before the Senate Banking Committee, he said that this was one of the biggest steps that regulators and standard setters could take to bring to light a fuller picture of companies’ financial health. The expansion of fair value accounting would come as part of what the former official called the most dramatic rethinking of the financial regulatory architecture since the New Deal.

The former SEC Chair criticized the banking industry for using fair-value accounting as a scapegoat, which he called the financial equivalent of shooting the messenger. If financial institutions were accurately marking the books, he said, they would have seen the problems they are experiencing months in advance and could have made the necessary adjustments.

More broadly, the former official noted that the current crisis has been building for years as the regulatory system failed to adapt to dynamic and potentially lethal new financial instruments. As the markets grew larger and more complex in scope and in products offered, he continued, the SEC failed to keep pace. As the markets needed more transparency, the SEC allowed opacity to reign. As an overheated market needed a strong referee to rein in dangerously risky behavior, the Commission too often remained on the sidelines.

As Congress examines what went wrong, he observed, it will find that a lack of transparency, a lack of enforcement, and a lack of adequate resources all played a key role. Even now, after what markets have undergone the past few weeks, he emphasized, regulators still do not know the full extent of the losses incurred by financial institutions and other companies on mortgage-backed securities. This lack of information about where risk resides is keeping investors suspicious and out of the markets.

That said, the former SEC Chair believes that an adequately staffed and resourced SEC can restore trust in the financial markets and can yet be again the crown jewel of the financial markets that it has been for the past 75 years. In this regard, he urged Congress to increase the SEC’s budget and staffing levels to keep pace with financial innovation.