‘Fair value is not fair’

As policymakers in Washington DC and in capitals worldwide contemplate
changes in accounting standards to stem the financial meltdown, one of the men
leading the charge against fair value is Wayne Abernathy.

He is the executive vice president for financial and regulatory affairs at
the American Bankers Association, an influential trade group that for years has
railed against fair value or mark-to-market accounting.

The fair value rule has been at the centre of debate over financial
regulation, with the US Securities and Exchange Commission looking at whether to
overhaul a system ushered in more than a decade ago.
Critics claim it has sped the downward spiral of the financial system by forcing
banks and other firms to value assets at a market rate even when little or no
market exists.

The subsequent write-downs have blown up balance sheets, forcing banks to
sell more assets
to raise capital and scared off potential buyers.

Fighting fires

In an interview last week with Accountancy Age, Abernathy likened
the financial crisis to a house fire ­ mark-to-market rules may not have been
the root cause, but it helped it spread to the upper floors. ‘It is an
accelerant,’ he explained. ‘It didn’t light the fire, but it made it of huge

Abernathy, a former assistant treasury secretary in the Bush administration,
argues that mark-to-market reporting distorts the value of assets that were not
acquired for the purpose of reselling. This puts banks in particular at a
distinct disadvantage. ‘Most of the kinds of loans that banks make,
mark-to-market doesn’t apply,’ he said.

Abernathy offered a grim prognosis for the economy if fair value rules are
not rewritten. He predicted that the global financial meltdown would ‘continue
the spiral until the market finally reaches a false bottom’. He blamed fair
value not only for the current financial woes but also for exacerbating the dot
com bubble of the late 1990s and the housing bubble more recently.

Mark-to-market accounting, he said, inflates prices during an upswing and
vastly understates them during a downturn.

He pointed to the wild swings in the energy sector, where oil prices hit
record highs over the summer but have dropped precipitously since.

‘People a year ago were saying why does the price of energy keep going up?
Because mark-to-market makes it look good,’ he said.

‘If you look at energy companies, they’re now having to book very good assets
below what their
actual value is.’

Speaking calmly but confidently as he sat in his eighth floor office in the
capital’s downtown district, Abernathy cuts an image of a university professor,
as he outlines his argument in an increasingly controversial debate that goes to
the heart of business.

Top firms have staunchly defended the fair value system, saying criticism of
the reporting rules is misplaced and akin to blaming the messenger for the risky
loans and management decisions that underlie the crisis.

Getting rid of mark-to-market rules, they argue, would make accounts opaque
and allow companies to mask the bad assets that are weighing down their books.

Fair’s fair

Abernathy acknowledges the push against fair value is an uphill fight,
starting with public relations. ‘I will admit they have won the rhetorical
battle by calling their model fair value,’ he said with a laugh. ‘I remember
reading something recently where one of the accountants is saying, “So you’re in
favour of unfair value!” Our point of view is that fair value is not fair.’

He also sought to turn the argument for transparency on its head. ‘You’re
transparently looking at the wrong thing,’ he said. ‘Just because the window is
clear doesn’t mean you’re looking at the right place. You’re not looking at the
real value. You’re transparently looking at what you could sell those assets for
in the marketplace. But that’s not the real value of those assets.’

Assets, he said, should be valued based on how they perform their intended
function, and not the price they would sell for on a given day. Take a loan for
a restaurant, for example. If the purpose of the loan is to make a profit on
interest payments, and not on reselling the loan, then the value of the loan
should be determined based on whether the borrower is meeting the terms of the
contract and not on the hypothetical price that a firm could get for selling the
loan, particularly if the market is distressed. ‘It’s still performing as
advertised. Why should I pretend it’s half the value that it was?’ Abernathy

The ABA is pushing regulators to adopt a ‘mixed model’ approach that would
keep fair value accounting rules for financial instruments that are traded in
the marketplace or for entities whose business models are based on fair value,
but eliminate the requirements for other assets. The SEC has been studying the
issue and held a public roundtable last week in Washington, the second such
forum it has held in a month.

Road to recovery

Abernathy said he does not know what impact the incoming Obama administration
might have on the fair value debate, adding that he did not hear the issue
discussed during the presidential campaign. ‘I don’t see a Republican-Democrat
divide over the issue of accounting standards. I think that’s good,’ he said.

‘I think it will help the economy if we get it right, and I think it has hurt
the economy dramatically by getting it wrong.

‘If we don’t solve this problem, we’ll continue to have boom-bust cycles, and
they’ll accelerate.’

He did voice optimism that regulators across the globe were recognising that
the question of mark-to-market rules needs to be addressed and he praised a
decision last month by the International Accounting Standards Board (IASB) to
ease fair value requirements.

The SEC had announced a similar move, but the ABA said the interpretation by
the US Financial Accounting Standards Board hamstrung banks.

The bankers association has been generally supportive of efforts at
convergence through international financial reporting standards, but has raised
a number of concerns about how the shift would be implemented, specifically
whether the move would be required or optional.

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