The financial crisis is turning many things upside down. Nevertheless, it is amazing to see how the positions of key market actors on financial reporting standards have changed since the crisis started. While investment banks, accounting firms, regulators and governments in the heyday of financial market capitalism stood firmly together in unanimous and unfettered support of fair value accounting, this front has been collapsing.
In April 2008, Neue Züricher Zeitung reported Claude Bébéar, president of the French Insurance Group Axa, as saying that mark-to-market rules which require firms to value assets according to (hypothetical) market prices had contributed to the financial crisis. Henri de Castries, CEO of the same group, was quoted as referring to a “conceptual mistake” which had forced companies and banks to write down billions of assets. In September 2008, Newt Gingrich commented on Forbes.com “Suspend Mark-to-Market Now!”, quoting Brian S. Webury, chief economist at First Trust Portfolios of Chicago:
“It is true that the root of this crisis is bad mortgage loan, but probably 70% of the real crisis that we face today is caused by mark-to-market accounting in an illiquid market.”
With the financial crisis lingering on and politicians, regulators and banks still searching for solutions, debates on the pros and cons of mark-to-market accounting have perked up again during the last weeks.
On March 11, 2009, investor Warren Buffet admitted in an CBNC interview that mark-to-market had been “gasoline on the fire” while remarkably equivocally maintaining that
“the best way to handle that (the crisis) is to have the mark-to-market figures but not have the regulator say we are going to force you to put up more capital based on these mark-to-market figures.”
Others have been more straight forward in their demands to suspend mark-to-market. On March 12, 2009 Edward L. Yingling, president and CEO of the American Bankers Association stated at the House of Representatives Subcommittee on Capital Markets that
“For months, we have specifically asked FASB to address the problem of marking assets to markets that were dysfunctional. …We hope that FASB and SEC will take the significant action that is needed and not merely tinker with the current rules.”
Subcommittee Chairman Republican Paul E. Kanjorski, according to CCH Financial Crisis News Center, warned that if regulators and standard setters “do not act now to improve the standards the Congress will have no other option but to act itself.”
From a Europan perspective, these are pretty strong words given that the US was long seen as the bastion of fair value accounting rules, with the SEC and the national standard setter FASB spreading its mark-to-market gospel to Europe and other continents. What does this mean then for the future development of the International Financial Reporting Standards produced by the London-based International Accounting Standards Board, adopted by the European Union on January 1st, 2005?
Prior to the implementation of IFRS by the European Union Committee, the IASB had undertaken so-called comparability and improvements projects which according to its critics moved the standards much closer to fair value accounting. Pro-cyclical and unintended consequences of mark-to-market accounting have been a longstanding concern in continental Europe and Asia, some of which Tomo Suzuki and colleagues at the Oxford Said Business School have surveyed in a research project on the Unexplored Impacts of IAS/IFRS on Wider Stakeholders.
Ironically, then, one of the beneficial side effects of the crisis could be that it is alerting the international community of experts and politicians involved in financial market and accounting regulation to a long overdue need to reform accounting standards. As the High-Level Group on Financial Supervision in the EU, chaired by Jacques de Larosière, states in unequivocal terms in its report (PDF): “accounting standards should not bias business models, promote pro-cyclical behaviour or discourage long-term investment”.
One should be careful, however, to not accept the current outcry of banks, regulators and politicians at face value. Behind the same rhetoric, one can find very different interests, motivations and positions: insolvent banks lobbying the US congress for suspension of mark-to-market reporting; US politicians aiming to discontinue or modify accounting standards in an instrumental way to write off toxic assets and return to normality once the crisis is over; regulators in charge of financial reporting standards, such as FASB and IASB, trying to get themselves out of the line of fire while still defending the merits of fair value in “normal times”; Angela Merkel and Peter Steinbrück (Financial Times Deutschland, March 23, 2009, page 1) following their US colleagues to free banks from fair value for the period of the crisis.
A short-sighted repeal of current standards for purely instrumental purposes of writing of toxic assets, however, does not seem the right way to prepare the ground for the necessary far reaching reforms. Interestingly enough, the Turner Review (PDF) of the UK Financial Services Authority published a few days ago, does indeed search to solve the financial crisis with more promising means.
Taking a critical stance on the public outcry for writing off toxic assets by means of suspending fair value does also not mean sharing the conservative view of the leading accounting firms which seem to be more concerned about avoiding any liabilities for ambiguities in their interpretation of reporting rules rather than worrying about how to bring the crisis to an end. On the contrary, I would say that the real test for a far-reaching reform of financial reporting standards towards rules that support economically sustainable development is still to come.
To work towards such a financial reporting system will, as suggested by the Larosière report (PDF), require opening up the standard-setting process of the FASB and IASB and including a variety of regulatory, supervisory and business communities. One might even go further and demand the inclusion of representatives of various stakeholder and civil society groups effected by accounting standards. This might not only prevent “group think” of the kind that we have seen enough of in the past, but it could also improve crisis management and lead the way to a substantially revised set of financial reporting standard which are neutral, non-cyclical and sustainable.