Peeling away financial reporting issues one layer at a time

Suspending Fair Value: Some Congressmen are Suspending Their Principles

While most politicians in Washington were trying to figure out how to solve the current financial crisis with real cash, my congressman*, John Shadegg (Rep. – Arizona), and a few of his colleagues have been fiddling with accounting rules while Rome burns. Flying in the face of the vast majority of investors, the AICPA, the FASB and financial commentators like Floyd Norris and Jonathan Weil, Shadegg and his cohorts made their entire case to the SEC in a three-paragraph letter, to take the significant step to "immediately suspend Mark to Market rules."

The first paragraph of the letter to the SEC Chairman, Christopher Cox, reads thusly:

"We are writing to urge that the Securities and Exchange Commission (SEC) immediately shore up the capital of the nation's banking system by suspending the use of fair value accounting or 'mark to market,' and replace it with a form of mark to value that more accurately reflects the true value of the asset. Although the mark to market accounting method can raise important red flags, in an illiquid market it has become counterproductive and is simply making the situation worse."

Are we to believe that out of the thin air of the financial crisis, these lawmakers somehow acquired the wisdom to know that some other form of "mark to value" (whatever the heck that means) "more accurately reflects the true value of the asset" than estimates based on available market data? Setting aside the question of where they get the chutzpah, I find it ironic that so many Republicans can so quickly cast aside their putative free-market principles just when efficient financial markets are trying to tell them something very important they evidently don't want to hear. 

To be as generous as possible, the only way their argument that a more accurate valuation of toxic loans can exist is to make the heroic assumption that a financial asset is somehow worth more when held by its current owner then by the market participant who values it highest.  This is nothing more than a variation on the greater fool theory: if a bank can't find anyone who is foolish enough to take a toxic loan off its hands at the loan's "true value", then doggone it, these lawmakers trust that bank management (who incidentally got us into this mess) can show us how to get water from a stone.

The second paragraph gets even worse.

"In periods of market turmoil, financial institutions are forced to write down the value of long-term, non-trading assets below their true economic value. The 'mark to market' rule, while well intended, has the unintended consequence of exacerbating economic downturns by hamstringing the ability of banks to make loans to consumers and businesses."

Shadegg and his cohorts are trying to make the argument that the accounting rules have gotten us into this mess, and "more accurate" (read "fudged") valuations will get us out.  Or, perhaps they are saying that sound capital adequacy rules should be suspended when they are breached.  Either way, the false premise they promote is that changing the picture painted by accounting somehow changes the financial institution itself. As Lynn Turner put it in his editorial, the banks and their political agents want us to believe we can make the situation better by shooting the (accounting rules) messenger.

If banks are not currently lending money, it can only be for one of three reasons: (1) they don't want to, (2) they don't have any, or (3) they are legally prevented from lending by the existing capital adequacy rules. If the correct answer is (1) or (2), there is nothing that the Shadegg group or anyone else in Washington can do – except to do what they have already done: give the banks taxpayer money to lend.

But, if the answer is (3), then I suppose you could induce banks to lend more money by allowing them to fudge their accounting numbers so as to get around the math of the capital adequacy constraint they currently face. Alternatively, and this is the crazy part, lawmakers could actually do something real—like passing a law that permits banks to blow past their capital adequacy limitations. That's obviously not politically acceptable, but somehow fudging the numbers to do exactly the same thing is quite acceptable for the SEC petitioners.  Permitting banks to fudge the value of their assets not only is shooting all the messengers (accountants and market traders), it is the functional equivalent of throwing away capital adequacy standards to double down after having already lost billions through lax regulation.

As a final aside, Shadegg's office issued a press release trumpeting the initiative as coming from a "bipartisan group of more than 60 lawmakers." In fact, 58 Republicans signed the letter, and only 7 Democrats did so. Fuzzy press releases, fuzzy accounting… what's the big deal?  If hyperbole and fudged accounting is permissible in press releases and bank financial statements, then branding oneself a man of principle in campaign ads could very well be more of the same.

Congressman Shadegg, if I were you I would drop the "man of principle" shtick and give "accounting maverick" a shot.


*Full disclosure: I have contributed some of my time and money to the campaign of Shadegg's opponent, Bob Lord.


  1. Reply Kevin Brown October 8, 2008

    The banks and other financial institutions got into this mess because they thought the boom would never end and that FAS 159 was a way to generate profits that went uncaptured by the financial institutions. However, just as 159 was implemented on an early basis the boom hit a wall and collapsed. Then of course what 159 gave, then 159 began to take away. This is the price of taking the fair value option and being required to reveal more info on fair value using the techniques proposed by 157 to determine fair value.
    As for the solution to this problem, these financial institutions need to deal with reality and ride out the storm as best they can. There are no easy fixes and looking and proposing easy solutions is no solution at all.

  2. Reply Superheater October 9, 2008

    I oppose so-called “fair value” because it isn’t based an actual transaction. Unless I actually secure a buyer and a payment, its a fiction.
    I oppose people in Congress generally and their involvement in matters such as determining the proper amount of water that should be used by toilets or the accounting principles that should be used in business.
    Reviewing the signatories to that letter reveals a curious amalgam of those that have aptly demonstrated total ignorance on economic matters and those who have demonstrated enough economic reasoning to have known better than to affix their signature.
    Of course this is nothing new. I suggest people read “Enterprise Denied” (forgot the subtitle) by Albro Martin, which chronicles the impassioned speeaches of legislators decrying the evils of “surplus”, which we know refer to as “retained earnings”.

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