As part of government efforts to contain the international credit crisis, U.S. lawmakers granted the Securities and Exchange Commission authority on Oct. 3 to suspend the so-called \u201cmark-to-market\u201d accounting rule, blamed by some for massive financial writedowns.
The rule, which requires valuations of assets to be pegged not to their original price, but instead to their current market price, has been strongly criticized in recent months by financial executives, led by Stephen Schwarzman, the CEO of New York-based private equity firm, the Blackstone Group<\/b>.
Critics of the rule say that in turbulent or frozen markets, companies that own assets with plummeting valuations may be required to overstate losses, which may quickly be recovered when markets stabilize. \u201cThe rule is accentuating and amplifying potential losses,\u201d Schwartzman has argued.
Authority allowing the SEC to suspend the mark-to-market rule was included in the bailout bill, which established an estimated $700-billion in funding for government purchases of troubled assets.
But the SEC\u2019s willingness to use its new authority to suspend the rule outright is uncertain. \u201cI\u2019m not sure what to make of the authority given to the SEC,\u201d says Peter Martin, accounting standards director for the Canadian Institute of Chartered Accountants<\/b>. \u201cSince some U.S. Congress members have been lobbied hard to enact a suspension and others were strongly opposed, perhaps they compromised on a step that gives the job of investigating the issues and the power to act to the SEC.\u201d
Three days before Congress gave it legal authority to suspend the rule, the SEC released a clarification of the rule. The SEC offered a new degree of flexibility, directing that \u201cwhen an active market for a security does not exist, the use of management estimates that incorporate current market participant expectations of future cash flows, and include appropriate risk premiums, is acceptable.\u201d
As Congress grappled with emergency legislation to counter the credit crisis, the mark-to-market rule became a central preoccupation, partly because banks are now preparing their statements for the disaster-laden third quarter. More than 60 U.S. lawmakers \u2014 including 55 who had rejected earlier legislation without provisions to suspend the mark-to-market rule \u2014 wrote to the SEC on Oct. 1, demanding that the rule be suspended.
While granting the SEC authority to suspend the rule, Congress has demanded that the SEC prepare a detailed study of the issue within 90 days. If the mark-to-market rule is suspended, it could have a dramatic impact on the government\u2019s Troubled Asset Recovery Plan legislation, which was enacted into law along with SEC authority to suspend the rule. Under the new plan, the government proposes to purchase downgraded assets.
In congressional testimony Sept. 24, U.S. Federal Reserve Board chairman Ben Bernanke emphasized that the current asset valuations may not reflect fair value: \u201cIt\u2019s possible for the government to buy these assets, to raise prices, to benefit the system, to reduce the complexity, to introduce liquidity and transparency into these markets and still acquire assets which are not being overpaid-for in the sense that under more normal market conditions, and if the economy does well, almost all of the value can be recouped by the taxpayer.\u201d
Peter Orszag, of the nonpartisan Congressional Budget Office, also agreed in congressional testimony that it is \u201cat least possible that the prices of some assets are below their fundamental value.\u201d
Congress agreed to suspend the rule following heavy lobbying by financial services companies, notes Paul Miller, a professor of accounting at the University of Colorado, who has worked at the SEC. \u201cIt was a political sop that allows proponents of suspension to report to their constituents and donors in the banking industry that they achieved something while, in effect, achieving nothing,\u201d Miller says. \u201cI am confident that the SEC will not suspend mark-to-market. It\u2019s not in its DNA.\u201d
Mark-to-market valuations have been employed in the mutual fund industry for decades, Miller notes. The move to apply them as a rule across the financial services industry came in the 1990s, following the U.S. savings and loan crisis.
The Canadian Accounting Standards Board<\/b> issued an Oct. 2 statement concurring with the SEC\u2019s decision to allow accountants to apply their judgment in assessing an asset\u2019s value, rather than allowing market prices strictly to dictate valuations.
\u201cGenerally accepted accounting principles require many investments in stocks and bonds to be measured at fair value,\u201d says CASB chairman Paul Cherry. \u201cCanadian companies are being asked to make a realistic estimate of the holding\u2019s fair value as of the balance sheet date and then clearly explain to investors how that figure was determined. In determining a holding\u2019s fair value, companies must estimate the price that market participants would sell for, or buy at, in an active liquid market, if there were one.\u201d
@page_break@In the period since the credit crunch began with the asset-backed commercial paper crisis a year ago, the CASB has issued three clarifications on the topic. A fourth can be expected shortly, says Cherry. In the meantime, he recommends that any complaints regarding the upholding of mark-to-market rules should be taken up with the Office of the Superintendent of Financial Institutions.\tIE<\/b>
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