SEC: Mark-to-Market’s Not the Problem

The Securities and Exchange Commission, in a Congressionally-mandated and extremely long 211 page report released Tuesday, suggested that a controversial accounting standard has had little to do with the financial meltdown and does not need to be suspended. The debate over of the effect of FASB Statement of Financial Accounting Standards No. 157, Fair Value Measurements, which went into effect November 2007, has been one rarely afforded to any accounting standard. Critics have pointed to the accounting standard — which provides a framework for market participants to mark securities books to market prices — as fueling much of the nation’s credit crisis, or at least helping make things far worse. “When [CDOs and other mortgage derivatives] started defaulting, out of bad luck or bad judgment, we implemented fair value accounting,” The Blackstone Group (BX) chairman Stephen Schwarzman said in September. “You had wildly different marks for this kind of security, which led to massive write-offs by the commercial banking and investment-banking system.” SEC officials concluded, however, that the fair value rules “did not appear to play a meaningful role in the bank failures that occurred in 2008,” according to a press statement. The conclusion is clear shot at a banking lobby that has pushed with increasing force during the year to see fair value standards suspended in an effort to protect banks that critics say have had to mark their books too aggressively amid market fear. “Among key findings, the report notes that investors generally believe fair value accounting increases financial reporting transparency and facilitates better investment decision-making,” the SEC said. The report said that failure of financial institutions was not due to the accounting standard, but instead the result of “growing probable credit losses, concerns about asset quality, and in certain cases, eroding lender and investor confidence.” The SEC, however, did recommend a number of possible improvements to the implementation of SFAS 157, centered mostly on the application of the standard in illiquid or inactive markets. In particular, as it has before, the SEC suggested that FASB provide more clear guidance on how to determine when markets become inactive, and whether a transaction or group of transactions are forced or distressed. The report is chock-full of other details, as Edith Orenstein over at FEI notes. “The SEC’s study on mark-to-market accounting may make a best seller’s list (among accountants, some lawyers, and public policy types, at least),” she writes in a post summarizing key points from the SEC study. Orenstein notes that the study isn’t likely to quell discontent among those critics who suggest that the accounting standard may not have caused the financial crisis, but that it did exacerbate its effect. “[W]hile fair value is used to measure certain assets such as trading securities and impairment losses on AFS [available for sale] securities, such declines in value were directionally consistent with the losses on the underlying loans and the current economic conditions, which impacted the value of these securities,” the SEC report reads. “A number of panelists and commenters have referred to fair value accounting as an ‘accelerant’ igniting liquidity spirals, and I am not sure how much comfort those in that camp will receive from the SEC’s finding,” she suggests. Read the full study. Write to Paul Jackson at paul.jackson@housingwire.com. Disclosure: The author held no relevant investment 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.