Financial Industry Groups Ask Congress to Redefine and Improve Fair Value Accounting

Noting that when there is no market, market value does not provide relevant, useful information about a securitized asset, the financial industry told Congress that the fair value accounting mark-to-market standard still needs additional improvement even in the wake of FASB’s recent guidance. In a letter to the leaders of the House Financial Services Committee, groups ranging from the American Bankers Association to the Financial Services Roundtable said that FASB’s emphasis on mark-to-market not only results in misleading information in a distressed market, but can also result in misleading information in a typical market. The current volatility of exit prices for many financial instruments in uncertain economic times has demonstrated how unreliable fair values can be, which can have severe adverse implications when determining total reported capital and undermine public confidence. The groups stopped short of asking Congress to suspend the fair value accounting standard, but they do want it improved.


In the industry’s view, accounting rules should follow the business model. If the cash flows to be received are based on an expectation the asset will be sold, then mark-to-market is appropriate. If the cash flows to be received are not based on buying and selling in the market, then it is not appropriate. Accounting rules should provide information about an entity’s financial condition and should not cause management to make decisions based solely on accounting outcomes.

According to the groups, the most important improvement would be to change the definition of fair value. The current definition, which was reaffirmed by FASB in its recent guidance, continues to mislead users of financial statements. In practice, the application of FASB’s rule defining fair value as “exit price” gives no consideration to what price a seller is willing to accept, and therefore, results in a downward bias in reported values. It is precisely what the associations called an ``immense difference’’ between the economic value of the underlying assets in the security and the prices brokers are offering that has frozen the markets. They urged that fair value be defined as a willing buyer and willing seller in an arm’s length transaction that is not a forced sale.

On a longer term basis, FASB has publicly stated its view that mark-to-market accounting should be required for all financial instruments, including loans. But, the groups told the committee that the result of such a requirement would be that many financial institutions would need to curtail their lending activities due to the risk of volatility from recording immediate mark-to-market gains and losses. Such a risk would also drive up the cost of loans to consumers for the increased financial reporting risk assumed. Thus, the industry groups urged that the current efforts to require that all financial instruments be marked to market be abandoned.

The groups acknowledged that the recent FASB changes to the accounting for other than temporary impairment (OTTI) represent a major improvement in financial reporting. But while FASB acted expeditiously at the Committee’s request, noted the groups, the changes only scratched the surface. For example, OTTI continues to result in higher losses for U.S. companies versus companies that follow international accounting standards (IFRS) and may unintentionally increase the number of bonds that become subject to an OTTI charge. Additionally, while the other changes made by the FASB on mark-to-market provide more specific guidance, which is useful for more consistent application of the rules, they do not focus on the heart of the problem, which is that mark-to-market does not provide the most relevant measurement basis for many types of transactions.

Finally, the industry groups cited recent remarks by former Fed Chair Paul Volcker that pushing mark-to-market accounting to an extreme during the crisis is a mistake since it can lead to a cascading decline in valuations. It certainly has led to inconsistencies among institutions, noted the former chair, but beyond that is the more fundamental problem that mark-to-market accounting may not really be consistent with the traditional financial system.

All regulated institutions that perform the vital function of transferring maturity and credit differences into a practical, money-making operation are intermediaries, reasoned the former Fed chief, and you can't intermediate if you can't take any maturity differentials or any credit risk.

The recent FASB guidance provided additional guidance on determining whether a market for a financial asset is not active and a transaction is not distressed for fair value measurements. Generally, if the market is not active, then a valuation technique other than one that uses the quoted price must be used. FASB also provided a clearer benchmark for when an other-than-temporary impairment exists and needs to be recorded on securities held outside of a company's trading book.