Tuesday, October 28, 2008

Round Table But No Camelot

A panel of financial experts will be gathered in Washington DC tomorrow. It has been billed as a “round table” discussion but will not have the Camelot ambiance - just the Securities and Exchange Commission and a gaggle of accountants, investment bankers and university professors discussing the mark-to-market or fair value accounting standard called FAS 157.

It is not likely to be a friendly affair as the views on mark-to-market accounting have become quite polarized in this new era of capitalism a la government bailouts. Representatives of the Federal Reserve Board, the Financial Accounting Standards Board (FASB) and the Department of Treasury will be on hand to break up any fist fights. Of course, SEC Chairman Cox will make closing remarks.

The recent post Mark this to Market” on October 21, 2008, discussed FASB’s exposure papers and comment request on amendments to standards FAS 140 and 46(R), which speak to applying mark-to-market or fair value accounting to off-balance sheet assets - QPSEs and SPEs. In that post, I suggested that investors need to find a way out of the “credit market hole” by some other means than to just keep digging.

The SEC’s solution is to assemble experts for a panel! What good this will do is subject to question. In this politically charged season, it could degenerate into finger pointing and partisan sideswipes. I hold out some hope that the discussion could provide some clarity for investors who are concerned about the impact of additional financial assets coming on the balance sheet at fair value.

In response to the "Mark This to Market" post, David Phillips, editor of the web log 10Q Detective and contributor to BNet.com, posed the question, “if the investments are securitized, how are the companies to ‘fairly value’ the QSPEs if they rarely trade or a limited resale market is available.”

We already saw what happened when FAS 157 went into effect for effect in November 2007 for those financial assets already on bank balance sheets. When active counter parties went away, the bank accountants turned to the third option provided by FAS 157 - mark-to-make-believe.

There are proponents of the fair value accounting principal. Indeed, I am attracted to the concept of keeping companies honest about asset values. The difficulty arises when there is no ready market for an asset or when the market is temporarily illiquid. The mark down of asset values quarter by quarter hardly provides a clear view on the situation during period of volatility. In fact, it could lead to a murkier picture than if the asset remained on the balance sheet at the purchase price. Furthermore, when the practical standards for such an accounting principal are imposed in the middle of a significant asset bubble such as we just experienced in the housing market, it makes for a messy start out of the gate.

The prospect of another splash of ice water from the addition to the balance sheet of QSPE and SPE assets at market value should give investors some pause in the coming months. This provides another reason to remain cautious in the return to long positions in the U.S. equity market, particularly in the financial sector.

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