Friday, March 14, 2008

Fair value accounting in the financial sector

I have flagged this issue before. Fair value accounting has come to the fore as a vexed issue in the present financial market crisis. Loans are not marked to market, so banks should not have had to worry. But they hold marketable securities and have huge positions in derivatives, both of which are marked to market. That is why banks- and not just investment banks or hedge funds- are feeling the heat this time around. FT carries a detailed report:

As the losses rise, anxiety is growing over the way these hits are being
measured. At present, accounting is dominated by a concept of “fair value”: companies are expected to report the value of their holdings in as “current” a manner as possible, which in practice means marking to market prices.

However, there is mounting concern that this approach creates distortions when markets are as dysfunctional as they are now. Indeed, some bankers fear that the system is actually making the crisis worse. Far from offering a reassuring yardstick, it is forcing banks and hedge funds to sell assets in a manner that is stoking investor panic...

...Many investors are sceptical about the accuracy of models used to
estimate the price of untraded assets. “When markets dry up there are problems with mark-to-market disclosure because there are no markets. Then people have to use mark to model but there are big problems with that too,” observes Charles Goodhart, professor of finance at the London School of Economics.

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