America’s Most Dangerous Man? An Accountant

August 6, 2009

Well, that didn’t take long. Just four months ago, the Financial Accounting Standards Board wisely knuckled under to Ccongressional cajoling and decided to ease its market-to-market valuation rules. But now FASB Chairman Robert Herz and his obscure accountacrats in Norwalk, Conn. are enthusiastically re-embracing “fair value.” They want to expand their application as never before, to include all financial assets, even loans.

All that, despite evidence that the change made back in April enabled banks to claim billions in additional first-quarter earnings (more than $3 billion at 45 large firms) and helped instill a needed dose of confidence into wobbly markets. Thus this new effort by Herz & Co. represents a triumph of ideology — that transparency trumps all — over practicality and experience. What if an upgraded mark-to-market standard forced slowly healing banks to set aside huge sums to cover paper losses and further crimp lending? Not FASB’s problem.

Now in a Greenspanian dream world of perpetual economic moderation, a mark-to-market may well be the ideal one-decision regulatory approach. Just set it and forget it. Whereat’s the risk in a pro-cyclical policy, after all, when the business cycle seems stuck firmly on “gentle”?

But stormy economic times can turn fair value into foul policy. Great Depression-era regulators, according to a 2008 Securities and Exchange Commission report, abandoned mark-to-market in 1938 because of “serious concerns” over how it was affecting systemic financial stability. And had money center banks in the 1980s been forced to mark those loans to market prices, argues former FDIC chairman William Isaac, “virtually every one of our money center banks would have been insolvent.”

Now let’s be clear. Fair value didn’t spark America’s financial crisis. Rather, as Warren Buffett aptly put it, mark-to-market was “gasoline on the fire.” (Though, as a purely historical matter, it should be pointed out that mark-to-market coincided nicely with two major U.S financial panics.) As such, a mid-crisis reevaluation of the standard should have been an easy call for FASB. It clearly wasn’t.

Not true for others, though. Earlier this year, the Group of 30 – an international body of banking and academic biggies – recommended that “fair value accounting principles and standards should be reevaluated [when] dealing with less liquid instruments and distressed markets.” Paul Volcker, himself a member, questioned the suitability of “across-the-board application of mark-to-market accounting,” which sounds exactly like what FASB is proposing. Even the International Standards Accounting Board seems hesitant to go as far as its American cousin.

But neither historical precedent nor present-day analysis seems to much matter to the Gnomes of Norwalk. The changes to mark-to-market didn’t further destabilize shaky credit markets. And those toxic asset-laden “zombie” banks are slowly earning their way to health, needing neither nationalization nor more government money.

Yet none of this has prompted even a tacit admission by FASB that every few generations rules may need to be massaged just a wee bit. Fair value is neither good nor evil; it’s just another tool in the toolbox, appropriate for some economic times perhaps and not for others. And with fragile credit markets still in recovery mode, now is not the time for FASB to try and bring it back with a vengeance.


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Mark-to-market [MTM] policy, if allowed to work itself out over time, will inevitably force lenders to make loans that are less likely to go bad – or at least to show the effects of risk on their books more explicitly. Does this mean it will “crimp lending”? Probably yes. It also means the loans that *are* made are likely to be of higher quality (unless management enjoys showing allowance losses every quarter)

The flip side, which finance guys rarely seem to point out, is that MTM valuations are not made in a vaccuum. Financial statements are comparative, giving perspective on dramatic changes in value. MTM is also rigorously disclosed in notes, and many MTM principles are handled through allowances so the carrying value and original value of assets are often evident.

It’s the responsibility of management to provide appropriately conservative estimates regarding value.

It’s up to the end users of statements to bet on the direction the markets driving asset values will move.

Long story short – don’t blame FASB for investors being easily spooked.

Posted by hariolor | Report as abusive

I feel the need to provide a 3×5 plain english perspective on why it makes sense to have mark-to-market.

If I make and sell widgets that are expensive, but very useful, it’s fair for me to tell people what it cost me to make them.

When another company starts making the same widgets, competition drives the price down a bit. So now I am selling widgets for less than it costs me to make them. It’s fair to make me report my inventory at the new market value.

Now what if someone suddenly realizes many of ingredients we use in the widgets cause cancer, and nobody wants them anymore, not even as scrap – because it’s virtually impossible to separate the ingredients used to make them.

Would it be fair for me to report them as worth more than zero, just because *some* of the ingredients in my widgets don’t cause cancer, even though the ingredients cannot ever be separated?

I’ll leave that to you to ponder.

The analogy, just to be really clear:

me = financial institutions
ingredients = loans to consumers
widgets = securitized assets and derivatives
cancer = bad loan losses

Posted by hariolor | Report as abusive

Yeah but what about the WMD that Iran is stockpiling. They cause cancer too, does that mean we have to ignore them too?

Posted by Ben | Report as abusive

[…] Pethokoukis is a 2002 Jeopardy! champion. Pethokoukis can be reached at … Read more: James Pethokoukis » Blog Archive » America's Most Dangerous Man … Share and […]

Posted by James Pethokoukis » Blog Archive » America's Most Dangerous Man … | americantoday | Report as abusive

Imagine that, a conservative making an argument for LESS transparency in corporate America.

Also, what kind of ‘slowly earning themselves back to health’ is it when it’s only based on accounting boondoggery? This is the whole essence of the problem! There is no real wealth or capital, it’s all imaginary keystrokes in some banks computer that be manipulated to tell whatever story seems best. Hogwash! The public – by themselves or via elected representatives – needs to demand more from companies that have taken charge essentially of our way of life. Is it not reasonable to ask that of the people and companies that rule our lives?

As per Ben’s comment… you, sir, are an idiot. But if you really want to do something about Iran, join the Taleban! They have FAR more chance of being disruptive to Iran than America.

Posted by the Shah | Report as abusive

Accountants should be forced to take Morality and Theology classes prior to becoming CPA’s.
God Created the Integers, just remember that 😉

Lawyers should have the equivalent of a credit report score but instead reflecting their moral standards. The smaller the moral standard credit, the less they’re worth paying, and so on.

Posted by Danny | Report as abusive

Forza Ferrari, Schumacher is coming back to Formula 1 baby!!!

Posted by Benson | Report as abusive

@ Danny –

Most states do require ethics education for those who wish to sit for the CPA. The real problem is that ethics is not something that can be taught in a few credit hours of classes. Especially not ‘business ethics’, which in my experience is taught as compliance with regulations and laws, and not real ethical reasoning.

Posted by hariolor | Report as abusive

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