SEC: fair value not to blame for financial crisis

Fair-value accounting did not play a substantial role in the downfall of large financial institutions last year, according to a report by the US Securities and Exchange Commission (SEC) released on December 30.

"Rather than a crisis precipitated by fair-value accounting, the crisis was a 'run on the bank' at certain institutions, manifesting itself in counterparties reducing or eliminating the various credit and other risk exposures they had to each firm," concluded the SEC.

The report, nevertheless, recommended several measures be taken to improve aspects of fair-value accounting.

First, the SEC believed additional guidance was needed to determine the fair value of an asset in illiquid markets. This recommendation came despite the Financial Accounting Standards Board (FASB) having released two sets of extra guidelines on fair value recently: on September 30, it published a joint paper with the SEC and on October 10, FAS 157-3 was released, containing further clarifications.

Second, the FASB should examine the impact of liquidity in the measurement of fair value. At the moment, a liquidity price is used to determine the fair value of an asset, which can be detrimental when valuing asset prices in illiquid markets.

Third, the SEC recommended enhancing disclosure requirements of fair value in financial statements.

Fourth, the FASB should re-examine its impairment accounting models, and possibly reduce the degree to which models are used under US generally accepted accounting principles (Gaap). The report also recommended the FASB reassess whether an institution should be able to record an increase in value of an asset once market prices recover, rather than marking it down permanently, as is currently the case.

The SEC's report was mandated by the Emergency Economic Stabilisation Act of 2008 (EESA), which demanded the SEC conduct a comprehensive review of fair-value accounting. In particular, the SEC was asked to examine FAS 157, an accounting rule that does not in itself require fair value, but rather describes how to judge the fair value of an asset. Under the EESA, the SEC could also suspend FAS 157 at its discretion.

Any such suspension, however, began to look improbable, with suggestions refinements rather than wholesale changes were required. SEC chairman Christopher Cox even publicly voiced support for fair-value accounting in a speech to the American Institute of Certified Public Accountants on December 8.

"We're pleased the report was supportive of FAS 157," says Neal McGarity, a spokesman at the Financial Accounting Standards Board (FASB), the independent standard setter for US Gaap. McGarity went on to say that, given the length and detail of the report - which totals 259 pages - the FASB was not willing to give any further comment for the time being.

As the crisis deepened in 2008, bankers began to argue that fair-value accounting was impracticable in illiquid markets. Such a valuation technique, they asserted, merely exacerbated banks' capital positions by forcing them to make unnecessary writedowns. In contrast, proponents of fair value underlined its worth to investors, who are presented with an accurate picture of an entity's current financial standing.

The Financial Crisis Advisory Group (FCAG), a group established jointly by the FASB and International Accounting Standards Board, announced its membership on December 30. The FCAG will focus on issues arising from the financial crisis, and is due to report back in the first half of 2009.

See also: Mark to market needs refining, not scrapping - SEC
Fair-value accounting critics call for action