Mark-to-Messy Accounting Change

  Fair-value rules soften, and investors cheer. A needed change now, but let's not forget the Enron era. Mark-to-market rules on valuing assets have been softened. Expect banks, hard-pressed to right their balance sheets amid imploding markets, and their investors to cheer. Not everyone is so happy. The Financial Accounting Standards Board voted Thursday to allow firms greater leeway in how they value illiquid assets. Currently, investments like mortgage-backed securities are priced based on their last sale. Since the seller is usually distressed and parts with their goods for a fire-sale price, all similar assets must be marked to a lower price. Critics of this brand of "fair value" accounting, outlined in FASB rule FAS 157, say it's crippled the banking system, forcing firms to continually write down the value of assets in the worst possible market conditions, regardless of whether or not they're for sale. This, in turn, has put tremendous strain on balance sheets, forcing financial companies to hunt for new capital to make up for paper losses at a time when few investors are willing to put money into banks. The spiral devastated the industry. As Forbes chairman and editor-in-chief Steve Forbes has noted in repeatedly calling for ending mark-to-market rules, of the more than $700 billion that financial institutions have written off, almost all of it has been book write-downs, not actual cash losses. "Mark-to-market accounting is the principal reason why our financial system is in a meltdown. The destructiveness of mark-to-market--which was in force before the great depression-- why FDR suspended it in 1938. It was unnecessarily destroying banks", he says (see: "End Mark To Market"). With the changes to rule 157, companies can now value the assets on their books as if they were unloaded in an "orderly" sale rather than dumped in a forced or "distressed" sale. The guidelines will apply starting in the second quarter, which began Wednesday. Good news for these uncommonly bad times, which demand bold remedies. But the point of FAS 157, critics of its repeal remind us, was to avoid the kind of dot-com bubble, Enron-era mark-to-fiction accounting that artificially inflated the value of companies, leaving investors holding the bag when optimistic company guesses met real-world market pricing. "[the changes] would basically give businesses more leeway to decide what they report is on their books. That can't help investor confidence," says Espen Robak, president of Pluris, a valuation advisory firm. "That means higher cost of capital for everyone." The Center for Audit Quality, a Washington, D.C.-based nonprofit, has said that letting firms make more subjective valuations will "reduce the transparency that investors seek" and "would have significant unintended consequences." One of the inadvertent effects could be that current methods, based on recent transactions, are rendered incomplete, forcing firms to spend time and money trying to assess what they have on their books. Investors will have to increase their own due diligence because reporting would be less standard and some firms might be more optimistic than others. "The ones who will benefit are the ones who push the envelope most," says Robak.