US Just Turned Off Its Financial Crisis ‘Early Warning System’
Oct 8th, 2008 | By Jennifer Yousfi | Category: Politics & EconomicsAn Improper Solution
Doing away with mark-to-market accounting rules to boost ailing financial firms is not the solution to the current credit crisis. Doing so would only increase the huge level of distrust already evident in the short-term credit markets and make financial institutions even more risk averse as transparency falls by the wayside.
And the markets will have given up the warning system that alerts investors to trouble brewing on a bank’s books.
“Suspending fair value accounting during these challenging economic times would deprive investors of critical financial information when it is needed most,” said the Council of Institutional Investors, Center for Audit Quality and CFA Institute in a joint statement, The Wall Street Journalreported. “It would not help solve our economic difficulties.”
With each bank relying on its own internal model to value the “toxic waste” on its balance sheet, investors would no longer be able to compare the financial statements of various firms. Any gain in CDO securities would be little more than an illusion.
“Institutional investors understand the banks are trying to escape more rigid standards and keep a higher level of flexibility in their valuation methods,” said SC&H Group’s Shifrin.
Despite calls from politicians for a relaxation of the standards, for now the SEC and FASB seem to be standing by mark-to-market standards.
“Financial reporting is meant to provide good accounting and good information for investors in the capital markets, and is not meant for other purposes,” FASB Chairman Robert Herz told reporters after a recent FASB board meeting. “Sometimes people try to subvert that with other objectives.”
As mentioned earlier, Money Morning’s Gilani has proposed a unique solution that would provide a universal measuring stick for these difficult-to-value securities, while staying true to important mark-to-market principles.
As part of his “Money Morning Plan,” Gilani recommends that the U.S. Federal Reserve set up a standard of valuation using “ a conservative, transparent pricing model” that takes into account “actual underlying cash-flow measures, projections and model specific criteria.”
This would allow financial firms to hold illiquid assets above their current dismal market value, while still ensuring that all financial firms are all adhering to the same pricing model.
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