Fair value: victim of a witch hunt

Is this the end of fair value? Are politicians in the process of turning themselves into the authority on accounting standards?

Not since the demise of Andersen and the Enron scandal has accounting held centre stage in a crisis the way it has become a central issue in resolving the credit crisis. As politicians in the US, UK and in Europe grappled with plans to stem the crisis they turned on fair value and mark-to-market accounting, blaming them at best for contributing to the collapse of the banking system, at worst for being one of its root causes.

Republicans called for its suspension, Hank Paulson reiterated the right to suspend in his rescue bill for the US economy, French president Nicholas Sarkozy and his finance minister Christine Lagarde have identified it as ripe for an overhaul.

EU president Jose Manuel Barroso has indicated his approval of a suspension and Tory leader David Cameron this week said something had to be done.

Politicians in short have become convinced that killing mark-to-market accounting is part of the answer to the credit crisis.

It is not known what Paulson might do with the legislation at this stage but together the politicians’ actions have left regulators and accountancy professionals speechless with astonishment.

One regulator told Accountancy Age: ‘Fair value is being used as a political football by people that don’t know what they are talking about. It’s political support for the distortion of the truth. It will cause regulators and auditors trouble.’

Knee jerk reaction

The highest levels of the profession are incredulous. One Big Four partner said: ‘Generally, politicians know even less about accounting than the rest of the world.

‘To have a knee-jerk reaction to try and change the accounting rules by next week seems like an inappropriate way to treat something [The IAS project] that’s taken 25 years to establish.’

Should the politicians be in this position? Should they be taking control or should standard setting be treated like the setting of interest rates by central banks ­ outside the control of politicians?

For US congressmen the question is easily put to one side because political control of the country’s national standard setter is within their grasp.

But for countries signed up to international accounting standards the position is very different because the IASB does not answer to any government or politician. As Nicholas Veron of the Bruegel Institute in Brussels points out, the fact that politicians should not interfere with international standards, is a function of geography.

That said the weekend saw French president Nicholas Sarkozy host a summit in which he dropped his own preference for suspending fair value.

Instead, the European leaders, including Gordon Brown, Angela Merkel of Germany and Italy’s
Silvio Berlusconi, called, among other things, for the same reclassification rules for assets that
exist in the US so that Europe’s companies would not be at a competitive disadvantage.

The rule allows for assets to be moved from ‘held for sale’ to ‘held for investment’ and thus avoiding the application of fair value.

Were the politicians pushing the IASB around? No, the IASB issued a statement the day before the summit signalling its willingness to look at reclassification as early as next week.

Its statement made two things clear however. Firstly, reclassification is ‘rare’. Secondly, a change to adopt the rule into IFRS will come along with anti-abuse measures.

This is then clearly not about allowing wholesale reclassification so that fair value will not apply. The IASB believes this is merely about levelling the playing field between the US and European competitors.

The IASB’s reclassification statement could well have been what was needed to head off a full frontal attack on fair value at the Sarkozy summit. Apart from the formal statements the board has retained a tactical silence, clearly not wanting to say anything that might upset rescue plans in the US or worsen the position of fair value in Europe.

Its cause might have been helped though by last minute lobbying launched on the eve of the European leaders’ gathering.

Just as everyone was packing their bags to head for Paris, the Association of British Insurers aggressively entered the fray putting out a statement demanding that fair value be left alone.

It was a clear indication that investors accept the accounting as it is and the politicians should heed the investors, it’s their interests at stake. Having said that, it is clear that no one quite knew what to expect from the meeting, perhaps least of all the leaders themselves.

The level playing field illustrates another worry. If the US does suspend fair value, European leaders will feel they need to do the same to maintain a competitive equilibrium. Everyone is concerned about unilateral action, like the Irish government’s guarantee for depositors, which attracted so much criticism.

Even if Europe stands by fair value while the US acts, the fall out would be damaging.

For one thing the whole project of persuading the largest capital market in the world to adopt international accounting standards would be called into doubt because international accounting standards currently embody fair value. This may be welcomed by some, but not at the cost of fair value.

There is however a much larger fear. If mark-to-market is suspended we might be saying goodbye for good. As one insider put it: ‘we’re trying to stop Europe from doing anything temporary. Solutions like this are rarely temporary. If it’s suspended there’s no way it will be allowed back’.

In the meantime, the credit crunch looks like it might be transforming accountancy just as it has transformed the capital markets and regulation. But in such a fluid environment, it remains to be seen whether it will be for the better.