Credit crunch sparks fair value revolt

Sir David Tweedie

UK companies and investors are turning against fair value accounting, as US
criticisms of the method cross the Atlantic and add to calls for its suspension
while the current financial crisis plays out.

The
Hundred Group of Finance Directors has added to criticisms of
‘mark-to-market’ accounting, the method whereby assets are valued at market
prices. Investors are also questioning the practice.

As markets have collapsed, banks have scrambled desperately to establish
values for their mortgage-related assets, leading to huge writedowns and, in
some cases, runs on the bank.

The problems have led some in the US and elsewhere to call for a suspension
of fair value. The calls have raised questions as to whether there is a viable
alternative and to accusations that the US banks were only too happy with fair
value when it increased profits.

The chairman of the Hundred Group’s financial reporting committee Ken Lever
said: ‘The so-called market prices of sub-prime debt are low due to the fact
that there is no-one willing to buy ­ in reality, much of this debt will never
default. The prices imply a level of default that is unrealistic.

‘The issue is that if you mark assets down, then the bank has a reduced
capability to lend, which impacts liquidity which, in turn, creates further
uncertainty leading to further reductions in market price and so it goes on,’
Lever said.

Robert Talbut, chief investment officer of Royal London Asset Management,
said. ‘This practice is now correctly being seen as very pro-cyclical,
potentially destabilising and not necessarily reflective of actual reality.
Perhaps the theoretical purity of mark-to-market should be tempered to reflect
that not all assets need to be disposed of immediately and therefore why value
them as such.’

The International
Accounting Standards Board, led by Sir David Tweedie, could suspend fair
value, though it is not minded to do so, it is thought.

The Financial Stability Forum, a regulators’ forum, has said relaxing fair
value rules could damage market confidence.