The US authorities on 2 April decided to suspend fair value or “mark-to-market” accounting — whereby banks and other financial institutions must attribute market values to financial instruments that they do not intend to hold to maturity, including collateralised debt obligations (CDOs), rather than pursue their former course of simply making up the value of such instruments.
The change has enabled US banks including Citigroup to return to the bad old days of smoke-and-mirrors accounting — which means investors will have much less reason to trust reported figures and risk being short-changed. It seems the Financial Accounting Standards Board (FASB) succumbed to bullying from Congress and from America’s powerful banking lobby before making its move. In my view it would have done the markets a long-term favour if it had been a bit less spineless.
It’s a shame the authorities didn’t listen to Lloyd Blankfein, chairman and chief executive of Goldman Sachs since July 2006. In an article published in the Financial Times in February (Do not destroy the essential catalyst of risk) Blankfein stressed that fair-value accounting has real advantages. Among these are that it can provide banks and other financial institutions with an early warning system, enabling them identify assets whose values are about to plummet before it’s too late.
Blankfein pointed out that Goldman Sachs values its entire balance sheet every single day on a fair value (or mark-to-market) accounting basis. This is what enabled it to identify assets on the brink of collapse and thereby to ride out the credit crisis in better shape than most rival institutions.
Fair value has been also championed by among others Sir David Tweedie, chairman of the London-based International Accounting Standards Board (IASB), who has been a rearguard action to preserve its integrity from interefering politicians. Now that the FASB has buckled, I’m afraid that Tweedie is on a stickier wicket.
In his Financial Times op-ed, Blankfein wrote: “I have heard some argue that fair value accounting — which assigns current values to financial assets and liabilities — is one of the main factors exacerbating the credit crisis. I see it differently. If more institutions had properly valued their positions and commitments at the outset, they would have been in a much better position to reduce their exposures.
“For Goldman Sachs, the daily marking of positions to current market prices was a key contributor to our decision to reduce risk relatively early in markets and in instruments that were deteriorating. This process can be difficult, and sometimes painful, but I believe it is a discipline that should define financial institutions.”
This blog post was published on 18 April 2009