Does Fair Value Accounting Need to be Fairer?

Battle lines are forming over the fate of FAS 157, the "fair value" or mark-to-market accounting rule. In the heat of debates in the halls of congress, the Securities and Exchange Commission (SEC) and the Financial Accounting Standards Board (FASB) announced that while it would not order a suspension of the rule, which would benefit banks as they prepare third-quarter reports, it would reinterpret the rule to give banks and their auditors more flexibility. Under the original interpretation of the rule, banks were forced to value assets at what some call fire-sale prices rather than using more realistic values that exist in an orderly market.

The American Bankers Association (ABA) applauded the decision, which they say will give auditors more accurately priced assets that are difficult to value under current market conditions. Critics of the decision argue that FAS 157 isn't the cause of today's problems and that it protects investors. "Apparently in the middle of a great crisis, everything is thrown onto the table but it would be unwise to undo hard-won battles," said Denise Valentine, senior analyst at AITE Group. "While it may be causing pain, the rule undeniably supports clients and asset owners by forcing the market to clearly and consistently value instruments and to make the process more transparent."

Just how much difference will the clarifications to FAS 157 make? According to a Wall Street Journal editorial by Holman W. Jenkins, Jr., the answer is that because accounting isn't an exact science, we won't know until we try -- and that much of the argument over mark-to-market really is "a political battle between CEOs and short sellers for control of the stock price."

Clearly, banks have fallen into a regulatory trap that couldn't have been anticipated when FAS 157 was ushered in and there's no denying that they're paying a large, unintended price. But the jury will likely be out for quite some time about whether it makes sense to water down the rule.