Last week in a panel debate broadcast on ABC, Arianna Huffington called the decision by the Financial Accounting Standards Board (FASB) to suspend mark-to-market "absolutely tragic." The issue Arianna identifies resonates with the implications of the actions agreed at the recent G-20 meetings in Washington and London. One of the immediate actions of the G-20 Washington Summit was "strengthening transparency and accountability" particularly with regard to financial reporting. This reflects two concerns: first, why was there no warning about the banking/liquidity crisis? Secondly, has the way bank results were reported created or exacerbated the crisis? This latter point is a criticism of fair value accounting -- or "mark-to-market."
The first issue has attracted less comment but is perhaps more complex. It is easy to look at the details of the accounts with hindsight and see how banks results were boosted by certain transactions. The transparency required by current accounting standards ensures we can see how banks were affected by increases in the market values of financial assets. However, it seems no-one realized the fragility of the markets in such securities. When problems first emerged in the sub-prime debt market, no-one was prepared to recognize the scale of the impact. In reality, we all looked for reasons why the problem would not be contagious.
Should accountants and auditors have identified these issues? Should regulators have realized the vulnerability of banks' capital and reserves? Should governments have recognized that a problem in one bank would affect others? The answer to all these questions is "probably." We believed that real value was being created by these new financial instruments and wanted to believe that the "good times" were here to stay.
The countries that form the G-20 must address this issue. They need to create a more skeptical environment where regulators challenge assumptions, ensuring companies have adequate risk assessment procedures.
That is why the current criticism of "mark-to-market" is so ironic.
Critics of mark-to-market suggest that forcing banks to write down the value of assets to their current depressed market value, creates liquidity issues. They say that the market prices we use are artificially low, feeding a fall in market values. Everyone has recognized the excesses in the banking system and that the lack of liquidity reflects real losses. Mark to market is not blamed for creating the crisis, but worsening it as markets fall. Critics suggest we could allow banks to hold assets at their current values, thus preventing further write-downs and restoring confidence and that consequently we'd see renewed stability in the financial market and liquidity restoration.
This is the opposite of "transparency and accountability." It avoids the need for banks to be accountable by pretending financial assets are worth more than their market value.
The only convincing argument for this is that market values don't reflect an asset's value because the market is not currently stable. The problem is that if a bank wanted, or needed, to realize any of its financial investments, it could only realize the current market value. Mark-to-market ensures transparency. Abandoning mark-to-market merely allows those who want to pretend that the crisis isn't real, to do so. A major concern is that we didn't have a sufficiently critical eye to anticipate the present crisis:abandoning mark-to-market would risk recreating the environment that led to the problems.
Mark-to-market can of course be improved. Let independent accounting standard setters determine the extent to which the current market has shown the need for changes. Let these changes be considered and free from political interference. Above all, let them be consistent given the global nature of banking.
The G-20 is right to have "strengthening accountability and transparency" as one of its objectives; it is important that they do so in financial reporting and do not look for a politically expedient solution that will damage this.
Jeremy Newman is the Global CEO of BDO