FAS 157 fair value - NEO gets Mr. Smith in Part 1

Just a couple of days back, i had commented on the SEC's move to change fair value accounting. This move was short changed with the bailout package being rejected.

Well on numbers, this is what fair value accounting has done so far since its inception in Dec 07.

Citibank announced a further $15-21BN write down for estimated Q3 on its distressed assets.

Morgan stanley wrote down $3BN in its Q3 earnings (not so bad as many expected $6BN)

Bank analysts predicted total write downs in excess of $64B on collateralised debt obligations from all investment banks.

Now with the bailout package being approved, heres what the SEC has proposed for Q3 reportings, which could just about reverse some of the write downs and infuse life into the financial statements

• Mark to Marking of assets and liabilities in inactive markets can now be done on the aandy dandy mathematical models instead marking them on the exit prices or fire prices in illiquid markets - which means auditors and accountants go back to reading more of CON 7

• SEC has allowed managements to use their internal assumptions in fair value accounting while maintaing the hieracy of using fair value techniques.

The crux of the SEC statement is primarily aimed at ensuring distressed assets are not marked to market in inactive markets at throwaway prices.  The concept of a fair value measurement assumes an orderly transaction between market participants. An orderly transaction is one that involves market participants that are willing to transact and allows for adequate exposure to the market. Distressed or forced liquidation sales are not orderly transactions, and thus the fact that a transaction is distressed or forced should be considered when weighing the available evidence. 

To make matters interesting, the US BIG ACCOUNTING FIRMS, which all along were silent on the rejection of the $700BN bailout package, were opposing congress efforts and were gearing to lobby to scrap the changes in the mark to market rules. 

FAS 157 fair value accounting revolutions- Will Neo get Mr Smith

I had mentioned this in my earlier blog "FAS 157 results in naked shorts selling ". Now in the latest manifestation of the heavy flak flying around fair value, critics have been emphasizing the great power that the Securities and Exchange Commission will have — to suspend mark-to-market accounting "for any issuer" and to launch probes into its role in the current financial crisis.

The bailout bill debated yesterday in Congress included sections giving the SEC power to suspend mark-to-market accounting "for any issuer" and to launch a probe into the question of whether it contributed to the crisis. Though the bailout plan has been rejected, the bill shows the concerns of the SEC towards this new rule.

Under the securities laws, the SEC would have the authority to "suspend, by rule, regulation, or order, the application of Statement Number 157 of the Financial Accounting Standards Board for any issuer...if the Commission determines that is necessary or appropriate in the public interest and is consistent with the protection of investors," according to Section 132 of the bill.

Further, Section 133 of the legislation would empower the SEC to launch a study of the effects of 157 on financial institutions, including depository institutions. The study would mull the effects of the standard on bank balance sheets; the impact of fair-value accounting on this year's bank failures; and how mark-to-market affects the quality of financial information provided to investors.

The FASB reacting to the heat it has to take from the legislators and bankers decided to postpone its webcast on FAS 157 which was scheduled for a 11 AM US time run yesterday. The eagerly awaited FASB was to discuss various issues on the implementation of FAS 157

Well the markets took a tanking yesterday with DOW (n) over 600 points, will the regulators stand up and ban FAS 157.

Naked shorts selling - blame it on FAS 157's fair value accounting

The co-incidence couldn't have been worse for the banking sector, FASB's re-loaded version of fair value accounting FAS 107 in the avtaar of FAS 157, times itself with one of the biggest credit crunches in recent times.

The GAAP's (FAS 157) intent was to provide investors with added transparency by forcing companies to mark to market assets and liabilities. On the contrary, many pundits feel that fair value accounting does the exact opposite. Instead of providing investors with a better picture of economic reality, fair-value accounting distorts market realities by leaving too much room for management's discretion and potential abuse.

So does FAS 157 lead to naked short selling (NSS) on the markets.....

Phase 1 to NSS a booming market- FAS 157 requires companies to mark to market its financial assets at the exit price in an active market. In a booming market with a lot of credit available, valuations of financial instruments head only one way and that is upupup, valuations are better as there are many takers for these instruments ...net result earnings per share & disclosure analysis of companies look and feel better.

Phase 2 to NSS - Hungry Investors and credit rating agencies - traditionally relied on making their own fair value assumptions on Companies, now with data being available freely in the financial statements, these become the new norm of valuations..sideeffects - reckless lending, bad investments,inaccurate credit ratings of securitized debt and off late betting heavily on Credit Default Swaps (ask Lay-man ooops Lehman). Fair value assumes that markets have "good information" culled from financial results and credit-rating reports. But if rating agencies and investors get their data from corporate financials — "which are themselves based on prices inflated by a market bubble, the accounting numbers support the bubble.

Phase 3 - The bubble gets bigger - As accounting numbers support the bubble, markets instead of relying on prudent valuations and controlling management excess, 'fair' values feed the prices back to the market."

Phase 4 - A Sub prime hits you.........Sub prime loans (meant for the lower echelons) hits credit liquidity in the world markets . This hits liquidity in exotic financial instruments meant for the higher echelons of the Corporate world. With lesser liquidity, there are no takers for financial instruments in an active market - as a result fair values suddenly collapse.

Many banks in the US were complaining that they had no takers for US Govt bonds last quarter... many were wondering as what value they had to ascribe to these bonds... well if you were to follow FAS 157 - record these instruments at exit price.. then zilch should have been the value.

Phase 5 - Hungry Investors (this time bears) and credit rating agencies are back at it again....... they value companies on the basis of fair values in the financial statements, bingo ..... the valuations in the financial statements result in lower enterprise value and earnings per share...sideeffects fresh lending and investments gets starved, inaccurate credit ratings are given for healthy companies, securitization pools look bad, and Credit default swap indices go down (ask Lay-man)

Phase 6 - Bad rating chase bad values, this circular chain worsens the credit crisis. Bears step in and start naked short selling in Companies....their stocks, debt programmes, securitzation portfolios, Lay-man oops Lehmans' Credit Default Swaps.

The crux of this issue is marking assets and liabilites to their exit price in active markets, in times of recession, when there are no active markets, FAS 157 forces companies to mark their assets down, though many of these companies have the stomach to hold onto these investments through the recession.

Well i heard certain punters hedging /betting on what will be the next set of fair values, accountants will disclose for their Companies in the coming quarter ...now that's a new derivative under FAS 133 isnt it...wonder ISDA already has it updated