FASB-IASB Group Discusses Fair Value, Financial Stability
Feb. 13, 2009
On Feb. 13, 2009 the Financial Crisis Advisory Group (FCAG) met in New York City. The group – a joint advisory group of the Financial Accounting Standaards Board and International Accounting Standards Board – debated tradeoffs and commonalities between "financial stability" objectives and "transparency" objectives vis-à-vis financial reporting, and discussed whether and how fair-value accounting should be improved. Also discussed was the topic of dynamic provisioning versus incurred-loss recognition for loans. Background is provided in the FCAG meeting handout. This was the second meeting of FCAG, which was formed in December 2008 to consider financial-reporting issues arising from the global financial crisis. The group is jointly chaired by Harvey Goldschmid, former commissioner, U.S. Securities and Exchange Commission, and Hans Hoogervorst, chairman, AFM (the Netherlands Authority for the Financial Markets); its members include leaders from the fields of business and government. Members from the U.S. include former SEC Chief Accountant Don Nicolaisen, Former President of the New York Federal Reserve Bank Jerry Corrigan, former Comptroller of the Currency Gene Ludwig and Vanguard Mutual Fund Group Founder Jack Bogle.
Synopsis Of Meeting
Below is a synopsis of the FCAG meeting. The questions are verbatim as listed in the FCAG meeting handout. NOTE: In some instances a FCAG’s co-chair said “I think we have a consensus” or “I heard a consensus.” However, the group did not take any formal votes, and on some issues, certain FCAG members were diametrically opposed.
1. At whom should general purpose financial statements be primarily aimed and why?
FCAG members indicated they believe financial statements should be aimed at investors, but noted there are different aims - and therefore potentially different information needs - between short-term speculators versus long-term investors. Additionally, some suggested using a broader term than "investors" to incorporate stakeholders such as lenders, depositors and others.
2. Should general purpose financial statements have a financial stability objective? Why or why not?
FCAG members expressed varying views on this point. Co-Chair Harvey Goldschmid said the objectives of financial reporting should be |‘integrity, transparency and neutrality." He appeared to imply, through questions like “Can we reconcile the need of prudential regulation and accounting transparency and integrity?” that financial stability and transparency objectives may differ; certain wording in the handout about "sacrificing" transparency for a financial stability objective also implied the two objectives may not necessarily coexist within the objectives of financial reporting. However, other FCAG members expressed the view that the two objectives could coexist, even if financial stability is not an express objective of financial reporting.
3. With specific reference to fair value, should financial stability or pro-cyclicality be considered even if a loss of transparency of information would result?
FCAG did not expressly address this question;, generalities were more or less addressed as part of question 2 above,
and fair value specifically was discussed under questions 5 and 6 below.
4. For whole loans, should we (a) retain the current accounting model based on amortized cost and “incurred losses” but stress the permitted use of sound judgment in provisioning or (b) move to a different approach, for example, to fair value or to a method based on “dynamic provisioning”?
As described in the FCAG meeting handout, dynamic provisioning appears to be a method by which financial institutions could accruing estimated future losses in excess of incurred losses. Current and former banking regulators on FCAG seemed more favorably aligned with this idea than other FCAG members. Former SEC Chief Accountant Don Nicolaisen expressed concern about this, saying the issue has been around for about 50 years, and wanted to know if the point of the question was to address how to accrue anticipated losses for a situation like we are currently seeing, akin to a "‘hundred- year flood,"’ and if the point was to predict how high the rising tide would go, and what future losses would occur. He said if FCAG were to address such an issue, it would be a "‘substantial undertaking;"’ he also said another consideration would be whether nonfinancial institutions would be permitted to accrue such provisions as well. FASAC Chair Dennis Chookaszian (an observer at the meeting) said this type of provisioning was common back in 1970 before FAS 5 came along, and movement against it was to curtail earnings management. Former Comptroller of the Currency Gene Ludwig said banks wanted to record more provisions, but were afraid of SEC action challenging that; Goldschmid noted that during the 1990s, when he worked in Washington, D.C., (he was formerly general counsel of the SEC under then-Chairman Arthur Levitt) the banking regulators had discussed similar issues with the SEC. Ludwig argued that management needs to be allowed to exercise more judgment in recording provisions; others decried that as a return to earnings management. There was also some discussion as to whether prudential (e.g. banking) regulators should address their concerns directly by issuing regulations as to reserved portions of equity or capital, and/or to limit executive compensation, dividends, or other payments, if they had concerns about potential future losses, and handling this through allocated reserves of financial institutions or Other Comprehensive Income (OCI) versus profit and loss (P&L) [(income statement] treatment.
5. What principles should determine when financial instruments are carried at fair value and when changes in fair value should be included in profit or loss (earnings)?
This question was addressed in tandem with question 6, below.
6. What additional guidance, if any, is needed in the area of determining fair value?
FASB Chairman Robert Herz, an observer at the FCAG meeting, expressed surprise that constituents didn’t avail themselves of the flexibility that he said is already part of FAS 157, Fair Value Measurement, which he said requires use of market values in "orderly" markets, and provides some flexibility in how to value when markets are not orderly. Chookaszian added that the clarification issued by FASB (presumably referring to FSP 157-3 “provides a clarification that gives you lots of flexibility but it is not being used, why [it’s] not used, difficult to come up with something credible, and you can’t ignore that fact that if you are a CFO or an accounting firm, you [may] get second guessed, when a year or two later the real numbers come out; even tough you believe it [at the time], you may not want to take that position… cannot ignore reality in the U.S. with substantial litigation risk; changing an accounting rule won’t do anything if people are concerned about that risk.” Ludwig observed: “One could say, ‘how can you be against fair-value accounting, it’s fair?’” He added, “The issue before the house is not whether it’s fair value, but whether it should be driven by market value. I would put to you we’ve clearly - not just in the court of public opinion - at a time when markets don’t function, you can’t use market values to be equivalent to fair value, we have driven economic reality, we haven’t reflected economic reality.” Goldschmid asked Ludwig: “Are you arguing with 157 [FASB Statement No. 157, Fair Value Measurement] in the U.S.? Which parts? Category 3? Or [that] you take too long to get to Category 3?” Ludwig replied, “Particularly when markets don’t function, but perhaps [as a] general rule, look at other [values], e.g. discounted cash flow, as a reflection of valuation of assets.” Other FCAG members said they would like to see a continuation of the mixed-attribute model, and that intent (e.g. intent to hold an asset) should be a significant factor in how an asset is valued. Other FCAG members stressed there can be a difference (particularly in illiquid markets) between "price" and "value." Herz said, “That’s a broad discussion, but how far are we going to go, I might support certain things for certain classes to use discounted cash flow, in fact [FAS] 157 tells you to do that.” He added, “Application in practice may be strained now because of market conditions, behavioral implications of auditors, prepares, to just find a price, but the standard doesn’t tell you to do that.” Rather, he said, “The question is: how far can you go in ignoring market price.” Jerry Corrigan, former president of the Federal Reserve Bank of New York, (and now with Goldman Sachs Group) expressed his support for fair-value accounting and decried reports of "draconian" calls for suspension of fair value. FCAG cochair Goldshmid observed such calls were not on the table at FCAG meetings. Corrigan also challenged the relatively low proportion of assets marked-to-market shown in the SEC’s report to Congress on mark-to-market accounting, saying, “I don’t think it is representative of the very large systemically important banking and universal banking groups; the incidence of the use of fair value I’m quite certain is a lot higher than the numbers that you would say for that relatively small but very important group of banks.” SEC Acting Chief Accountant Jim Kroeker, an observer at the FCAG meeting, replied: “The study took the 30 largest financial institutions, so it is included in the population.” Corrigan responded, “Those numbers just don’t sound right to me… Even so …I’ve looked at these numbers pretty carefully.” Corrigan added, “I don’t think it’s any surprise I say as a creature of my environment, I learned at Paul Volcker’s knee, historic, cost accounting, especially for loan type products, discounted cash flow, [like] Moses coming down from the mountain, and now after 15 years at Goldman Sachs - where I live and breath fair value for everything - I have a somewhat different view of who Moses is or was. In conclusion, I think watering down fair value is the wrong way to go, and if anything, [the] direction [should be], as suggested earlier, to find ways to improve it, and with those improvements in place, find ways to broaden its application.”
7. What are the best ways to bring about useful information regarding securitizations and other structured entities?
FCAG ran out of time before getting to this issue; the group was going to discuss it during the closed portion of the meeting following this public portion, and may also discuss it at its next meet on March 5 in New York City – see meeting schedule.
Additional information can be found in FEI’s “Detailed Summary of FASB-IASB Financial Crisis Advisory Group Meeting.” (Note: detailed summary can be accessed by FEI members only. See information about FEI membership.) Refer also to the official FCAG meeting minutes when they are posted.
Prepared by Edith Orenstein, Director, Technical Policy Analysis, Financial Executives International (FEI) based on listening to the webcast of the FCAG meeting. This summary does not reflect FEI opinion unless specifically noted above.