Mark to market: Regulators are joining accountants in the retreat from “fair value”, better known as mark-to-market, accounting. But they are missing an opportunity to be really fair.
The Basel Committee on Banking Supervision, a group associated with the Bank for International Settlements, has endorsed the efforts of the International Accounting Standards Board (IASB) to rework standards for asset valuation. One of the Basel group’s four requests is that the new rules “recognise that fair value is not effective when markets become dislocated or are illiquid”.
No details are provided, but the implication is clear: banks should be allowed to relax mark-to-market standards when prices drop to ridiculously low levels in frozen, panic-struck markets. Proponents of this flexibility argue that requiring banks to find capital to cover for paper losses worsened the recent crisis.
It’s probably fair to give banks an escape hatch during temporary market collapses. And when the time comes, bank bosses will be first in line in urging accountants to deviate from market-value principles.
But neither the IASB nor the Basel committee have paid much attention to the equally dangerous market mis-valuation on the other side: excessively high prices in bubble-times. Just as inadequate liquidity can lead to too low prices, excess liquidity can push prices too high.
The paper gains feel good at the time. Bonuses go up and banks have more capital to leverage up. Traders are encouraged to acquire – and create – more easily overvalued securities. That’s what happened before last year’s financial crisis. By the time the bubble burst, balance sheets were filled with so much rubbish that central banks and governments had to come to the rescue.
But while the risks from poor market indications may be roughly equal, the difficulty of dealing with these is not. For too cheap assets, accountants will find ready allies at the banks for mark-away-from-market accounting. But clients will fight tooth and nail against efforts to be sensible when markets are flying high. To counter that pressure, the IASB should make the deviations asymmetric: tougher on write-ups than on write-downs.