US economic reforms fails to address accounting most controversial issue - fair value
US treasury secretary Timothy Geithner has unveiled a sweeping overhaul of
financial regulations including additional controls over finance companies, but
economic analysts took note of one glaring omission from the Obama
administration plan: any mention of the raging debate over fair value accounting
‘One of the real failures of Geithner’s plan was to fail to address this fair
value issue,’ said Alex Pollock, a resident fellow at the Washington-based
American Enterprise Institute who is a vocal critic of mark-to-market rules. ‘A
comprehensive plan would have to fix fair value accounting.’
Mr Pollock speculated that treasury officials perceived the accounting debate
as ‘too controversial’ to include. ‘It was a rapid tap dance sideways on the
stage,’ he said of Mr Geithner’s draft legislation. What is more, the Geithner
proposals were announced as the US Financial Accounting Standards Board (FASB)
considers two revisions to the fair value rules.
The treasury secretary cited accounting rules only briefly in his prepared
testimony before Congress on March 26, where he laid out the Obama
administration’s plan to vastly increase regulation of the financial markets.
‘We need to examine our accounting rules to see whether, consistent with
investor protection, we can require firms to build up loan loss reserves that
look forward and account for losses in downturns,’ he said while explaining the
need for large firms to maintain higher capital requirements.
The Geithner proposals would give the US government broad authority to take
over any company – and not only banks – that are deemed ‘too big to fail.’ And
it would subject hedge funds and private equity firms to much stricter scrutiny
and oversight by regulators.
A close look at the fine print of the plan shows that accountants would be
impacted in other ways. Under the proposed legislation allowing the government
to assume control of troubled firms, the seized companies would be required to
undertake a ‘full accounting’ and provide annual reports to the treasury
secretary and the comptroller general of the United States. And in a nod to
transparency, those reports would have to be made available to the public upon
request. Accountants are also listed in areas governing potential liability for
wrongdoing or damages.
While neither the legislation nor Mr Geithner mentioned the debate over
mark-to-market accounting rules, analysts say the final outcome of FASB’s
deliberations will have a significant impact on efforts at broader financial
reform. In both cases, however, the current economic climate makes an immediate
shift difficult. ‘How do you implement these kind of changes in the middle of
the crisis?’ asked Patrick Finnegan, director of the Financial Reporting Policy
Group at the CFA Institute for chartered financial analysts.
The proposed changes announced by FASB would allow company managers more
discretion in valuing assets in an illiquid market. The proposals follow an
outcry from banks and financial firms that mark-to-market accounting
requirements forced companies to write down major losses on their balance sheets
based on unrealistically low values for certain assets.
Mr Finnegan said that just as Mr Geithner is trying to restore investor
confidence by reforming the regulatory framework, officials should be concerned
about overly loose accounting rules. ‘Once you start playing with accounting,
you’re just going to erode investor confidence,’ he said. ‘Changing the
accounting rules is not going to change the attitude of investors.’
The Institute is objecting to the proposed changes to the fair value
requirements, warning that they will allow financial firms to shade their
losses. ‘Investors will not be willing to commit capital to firms that hide the
economic value of their assets and liabilities. Reduced capital access will
restrict the ability of banks to diversify their funding sources and slow the
recovery process,’ the CFA Institute wrote in a letter of response.
The fair value issue has proven politically tricky, since supporters of its
use have claimed the standard as a mark of transparency and accused its critics
of wanting to hide key financial data from investors.
Mr Pollock is one of a group of scholars that blame fair value rules for
exacerbating the bust of the housing bubble and consequently the steep economic
downturn. He criticised mark-to-market rules for mandating the use of ‘panicked
prices of a panicked market,’ and he has called for significantly limiting the
scope of fair value. He has characterised the FASB changes as a step in the
right direction, although he supports a more dramatic shift away from the
Another prominent critic of fair value, the American Bankers Association, has
also weighed in to support the FASB proposals to grant more leeway for firms
Mr Finnegan, on the other hand, said the clamor for revising the fair value
rules has forced regulators to make changes ‘to try to soften the outcomes’ of
extreme market shifts that can either over-value or undervalue financial assets
on a balance sheet. ‘In theory they say they don’t want to eliminate fair value
reporting,’ he said of the Obama administration.