On October 29, 2008, the Securities and Exchange Commission (SEC) hosted the first of its two roundtable discussions on mark-to-market accounting. Pursuant to the Emergency Economic Stabilization Act of 2008 (EESA 2008), the SEC has been congressionally mandated to conduct a study on mark-to-market accounting by financial institutions in close consultation with the Department of Treasury and the Federal Reserve Board. The study is scheduled to be completed by January 2, 2009.

The roundtable participants represented a cross section of representatives from financial institutions, the investment community and other market participants, as well as special observers from the Public Company Accounting Oversight Board, Federal Reserve Board, International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB). Although the debate was lively, there appeared to be more agreement between critics and proponents than expected.


In 2006, the FASB issued its statement FAS 157, which established a mark-to-market determination of fair value and set forth the framework for the valuation of assets. Most recently, however, fair value accounting has become the subject of much scrutiny and political discussion, and its future remains uncertain. Many market participants and regulators are not clear as to what role the standard played in the U.S. markets’ decline. Further, financial institutions are facing increasing challenges in FAS 157’s application in the absence of market liquidity, which the FASB sought to clarify in a Staff Position it recently issued, which provides guidance on the application of FAS 157 in an inactive market.1 In addition, on September 30, 2008, the SEC’s Office of the Chief Accountant and the FASB Staff issued “Clarifications on Fair Value Accounting.” In the panelists view, however, more concrete guidance is needed.

On October 27, 2008, Robert Denham, Chairman of the Financial Accounting Foundation, the independent private sector organization that is responsible for overseeing FASB, wrote a letter to Chairman Cox, stating the importance of an independent entity charged with setting accounting standards, and urged the SEC not to recommend that Congress take any action to suspend FAS 157.2 Issues related to fair value accounting are not isolated to the United States. The IASB recently met to discuss the application of fair value accounting in an illiquid market as related to IFRS,3 and the European Union has also amended its present mark-to-market accounting standards.4

Fair Value Accounting in an Illiquid Market

Chairman Cox in his opening remarks noted that, “illiquid markets bring new challenges to the measurement of fair value that may not have been fully appreciated in past years. These challenges have brought into focus the need for further work on improving the tools that companies have at their disposal to achieve transparent, decision-useful reporting.”5 The consensus among the panelists was that the current market crisis faced by financial institutions was not precipitated by fair value accounting. Rather, some stated that the present problems were attributed to the sub prime market crisis. It was acknowledged by several panelists that fair value accounting, despite its inherent imperfections, remains the best method of measuring value and any fundamental change or suspension to its framework would run the risk of reducing investor confidence and restrict the flow of capital.

William Isaac, a former Chairman of the Federal Deposit Insurance Corporation, however, was highly critical of FAS 157 and expressed the view that it should be suspended. Further, he stated that mark-to-market accounting was directly responsible for the depletion of many financial institutions’ lending capacity. He noted that historical cost accounting as a standard was a superior method of accounting valuation and would provide investors with financial statements that were more accurate and reflective of a financial institution’s health.

Fair Value Accounting and Its Utility to Preparers and Users

Aubrey Patterson, Chairman and Chief Executive Officer of Bancorp South Inc., expressed the view that the application of fair value should not be the accounting model for all financial institutions. Rather, a determination of valuation should be conducted with the financial institution’s business model in mind or it would produce misleading results. He further noted that accounting as the language of economics should reflect economic activity and not drive it.

Is Fair Value Procyclical?

The panelists agreed that the application of fair value is procyclical, thus leading to increasing write-downs in down markets and increasing write-ups in good markets. In the declining markets, many have found that the application of FAS 157, which results in a write-down of assets, reflects the assets as undervalued. More recently, many financial institutions have been forced to assign an artificially low value to instruments on their balance sheet that are being held for sale, but that they do not intend to sell immediately. The procyclical effect, therefore, may provide a good indication of why fair value accounting should not be a significant component of the calculation of regulatory capital.

Next Roundtable

The SEC will host its next roundtable on mark-to-market accounting by financial institutions on November 21, 2008. The SEC is presently seeking public comment on mark-to-market accounting. All comments received will be publicly posted on the SEC’s web site.