On April 2, 2009 the Financial Accounting Standards Board (FASB) gave in to pressure from lawmakers and financial companies and voted to relax fair-value accounting rules. These changes to mark-to-market accounting allow companies to use considerable judgment in determining prices of some investments on their books. Mark-to-market accounting requires that banks mark illiquid assets to their market values which can lead to large write-downs. Banks have argued that this is unfair because they may not be planning on selling the assets in the short term, and the decreased market value may only be temporary. Supporters of mark-to-market accounting claim that the rule is important for transparency and that banks should not have freedom to value their illiquid assets.
This week we are joined by Kurt Schacht, the Managing Director of the CFA Institute Centre for Financial Market Integrity. Kurt is responsible for all aspects of the Centre's efforts to develop, promulgate and maintain the highest ethical standards for the investment community. Kurt has an extensive background in securities law and regulation, alternative investments, hedge funds, financial reporting and corporate governance matters.
Sound off on this week's buzz in the Comments Section.
First, Kurt, will you tell us about the Centre for Financial Market Integrity of CFA Institute and share with us your organization's objectives?
The CFA Institute Centre represents the views of investment professionals, including portfolio managers, investment analysts and advisors located in more than 130 countries worldwide. Central tenets of the CFA Institute Centre mission are to promote fair and transparent global capital markets and to advocate for investor protections. An integral part of our efforts toward meeting those goals is ensuring that the quality of corporate financial reporting and disclosures provided to investors and other end-users remains of high quality. The CFA Institute Centre also develops, promulgates and maintains guidelines encouraging the highest ethical standards for the global investment community through standards such as the CFA Institute Code of Ethics and Standards of Professional Conduct.
You have indicated that you believe investors won't be willing to commit capital to firms that hide the economic value of their assets and liabilities. Will you further expound on this comment?
We are in a very serious crisis of confidence as it relates to the balance sheets of many global companies that hold financial instruments as part of their asset base . . . particularly the banks and other financial service firms. We have just changed accounting rules to facilitate keeping the actual values hidden and not charge permanent losses on those instruments against income. How can true investors commit long-term capital to companies where the financial statements are falsified? We don't think they can.
From the earliest signs of the financial crisis last year, there has been so much talk about the need for transparency. This move by the FASB seems to fly in the face of that objective. Do you believe that most investors will view this as a short-term, politicized move?
Our member surveys strongly support fair value accounting and oppose steps to suspend or tinker with accounting rules as a way to fix bank capital requirements or to give the illusion that banks and financial conditions generally have improved. "Tell us the truth" is the mantra. They want accurate and timely information, in financial statements, in credit ratings and about the government actions to remedy the crisis. In our view, political pressure on accounting rules, which this is, just raises the suspicion level.
Some investor groups claim that the FASB rule revision will delay the recovery of the banking system. Do you agree?
This could easily be the case. There will be many eyes on how the new valuation and reporting rules will impact earnings, the size of Level III asset pools and the amount of asset impairments disclosed in notes to the financials. Simply stated, these are new tools available to ignore and hide the problem, like Japan.
One would assume that the objective of this new accounting ruling is to allow banks to report higher profits which will result in their making more loans. Do you believe it will have these results?
The goal is to stabilize bank equity and improve confidence generally. Until the bad assets are removed and the bank balance sheets are cleaned up, it is hard to see a return to loan business as usual.
What effect do you believe FASB's recent action will have on the Obama administration's recently announced public-private partnership to purchase troubled assets? Isn't that program dependent upon banks and investors agreeing on how to value assets?
We are concerned the accounting changes may result in the government (the taxpayer) either over paying for the assets under PPIP and/or having the value of those assets continue to be hidden on U.S. books and not properly reflecting any continued deterioration. Taxpayers are not only the lender of last resort, we become the "long-term holder" of last resort.
Historically, FASB has provided thorough reasoning behind proposed changes and then allowed those involved to give their feedback on them. This time, the board allowed only a few weeks for comments before acting. Do you believe this recent action will cause FASB to lose its credibility?
FASB is in a difficult spot. And what they are supposed to do is misunderstood by the public and often by the Congress. Accounting rules are supposed to be independent of political pressure, measured and collaborative in their creation/ enactment and done for the benefit of the end-user, i.e. investors. We fear FASB has lost an important measure of investor trust through these actions. Both the process and outcome were not in the interest of objective, independent standard setting. More importantly, these actions negatively impact one of the most important transparency standards at a critical time in our financial recovery.
We thank you, Kurt, for your time and insight.
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