SEC, FASB Issue Fair Value Guidance

Rarely have accounting standards generated so much attention as in the current financial crisis. The Securities and Exchange Commission and the Federal Accounting Standards Board, acting on growing pressure from banks and other sources, moved on Tuesday evening to provide guidance on the use of fair value accounting in inactive markets, just in time to ostensibly affect third quarter earnings. The update on implementation of SFAS 157, the so-called “mark-to-market” accounting provision, addresses one of the more contentious areas surrounding a proposed bailout of financial markets; opponents say the provision is driving uneccessary losses for banks, while supporters say the provisions are forcing banks to be more honest in their marks on bad assets. Either way, banks and some investment firms have complained profusely in recent weeks, saying that SFAS 157 was forcing them to mark their books below the so-called “fundamental value” of an asset — the same argument initially used by Treasury secretary Henry Paulson to sell an initial bailout proposal to lawmakers. Tuesday’s statement by regulators was timed to coincide with the end of the third quarter. Among other items, the SEC and FASB said that companies may opt to use unobservable pricing inputs — making an asset a so-called Level 3 asset — even if observable inputs exist, so long as such categorization is done when “significant adjustments” to observable pricing inputs are needed. Which of course, means that the accounting standard is far from cut-and-dried; significant leeway for management judgment exists. Read the full guidance >> Not that any of the clarifications offered by regulators and the accounting board, however, were anything new to most market participants with knowledge of how the accounting standard has already been applied at most financial insitutions holding illiquid RMBS, CDOs, and other securities. “I’m still scratching my head how this is different from the guidance already available,” said one source, and ABS/MBS analyst that asked not to be named. “It’s just more sentences, plus the Treasury plan pretty much effectively means that all these illiquid assets are other than temporarily impaired anyway.” “If I were an audit firm I’d take those reverse auction prices as ‘all it’s worth for the foreseeable future’ and whack everything like it in the portfolio I was signing off on,” said the source. More than anything, the statement was a likely signal that neither the FASB or the SEC intend to stand down and formally suspend fair-value accounting rules, as numerous financial institutions have pushed for in recent weeks. The original bailout proposal shot down in a key House vote Monday would have authorized Treasury to explore a possible suspenstion of FASB 157, but did not go so far as to explicitly call for the provisions to be withdrawn. More than a few analysts view the fair-value debate as a proverbial red herring, as banks look to deflect responsibility for lax risk management practices. “In the past couple of weeks, fair-value accounting has been under attack,” JP Morgan Chase & Co. (JPM) analyst Dane Mott wrote in a report, cited in a Bloomberg News story. “Blaming fair-value accounting for the credit crisis is a lot like going to a doctor for a diagnosis and then blaming him for telling you that you are sick.” Disclosure: The author held no relevant positions when this story was published. Indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.