Tuesday, January 27, 2009

Relaxing FASB 157

FASB 157 is the directive that requires companies to mark their assets to fair value whatever the fair value method is determined to be (mark to market, mark to model, etc.). Talking heads and politicians have been suggesting that FASB 157 should be "relaxed" because the market it correctly valuing securities and that banks are being affected negatively (asset writedowns) because of the stringent mark to market rules.

FASB 157 is a scapegoat for the poor risk management of investment banks, hedge funds, and commercial banks. If FASB 157 were relaxed, banks could inflate their capital levels above liquidation value and have no paper write downs. In real terms however, they would be committing fraud. Shareholders would be purchasing shares in a technically insolvent company. In fact, if banks were required to report the value of their current assets, many would be insolvent because they have swaps with the Federal Reserve (mortgage backed securities, credit card securities, etc. for treasuries).

Relaxing FASB 157 would be a terrible idea that would disregard the idea of transparency in financial reporting and increase uncertainty for investors. Investors would require a higher risk premium in credit and equity investments devaluing the companies. I still believe that all these insolvent companies need to be wiped out with their assets sold off to companies in better financial position at attractive rates of return. Only then will we be able to move on from this ugly disaster.

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