Posted on 09/30/2008 3:38:37 PM PDT by sanchmo
Washington, D.C., Sept. 30, 2008 — The current environment has made questions surrounding the determination of fair value particularly challenging for preparers, auditors, and users of financial information. The SEC's Office of the Chief Accountant and the staff of the FASB have been engaged in extensive consultations with participants in the capital markets, including investors, preparers, and auditors, on the application of fair value measurements in the current market environment.
There are a number of practice issues where there is a need for immediate additional guidance. The SEC's Office of the Chief Accountant recognizes and supports the productive efforts of the FASB and the IASB on these issues, including the IASB Expert Advisory Panel's Sept. 16, 2008 draft document, the work of the FASB's Valuation Resource Group, and the IASB's upcoming meeting on the credit crisis. To provide additional guidance on these and other issues surrounding fair value measurements, the FASB is preparing to propose additional interpretative guidance on fair value measurement under U.S. GAAP later this week.
While the FASB is preparing to provide additional interpretative guidance, SEC staff and FASB staff are seeking to assist preparers and auditors by providing immediate clarifications. The clarifications SEC staff and FASB staff are jointly providing today, based on the fair value measurement guidance in FASB Statement No. 157, Fair Value Measurements (Statement 157), are intended to help preparers, auditors, and investors address fair value measurement questions that have been cited as most urgent in the current environment.
* * *
Yes. When an active market for a security does not exist, the use of management estimates that incorporate current market participant expectations of future cash flows, and include appropriate risk premiums, is acceptable. Statement 157 discusses a range of information and valuation techniques that a reasonable preparer might use to estimate fair value when relevant market data may be unavailable, which may be the case during this period of market uncertainty. This can, in appropriate circumstances, include expected cash flows from an asset. Further, in some cases using unobservable inputs (level 3) might be more appropriate than using observable inputs (level 2); for example, when significant adjustments are required to available observable inputs it may be appropriate to utilize an estimate based primarily on unobservable inputs. The determination of fair value often requires significant judgment. In some cases, multiple inputs from different sources may collectively provide the best evidence of fair value. In these cases expected cash flows would be considered alongside other relevant information. The weighting of the inputs in the fair value estimate will depend on the extent to which they provide information about the value of an asset or liability and are relevant in developing a reasonable estimate.
Broker quotes may be an input when measuring fair value, but are not necessarily determinative if an active market does not exist for the security. In a liquid market, a broker quote should reflect market information from actual transactions. However, when markets are less active, brokers may rely more on models with inputs based on the information available only to the broker. In weighing a broker quote as an input to fair value, an entity should place less reliance on quotes that do not reflect the result of market transactions. Further, the nature of the quote (e.g. whether the quote is an indicative price or a binding offer) should be considered when weighing the available evidence.
The results of disorderly transactions are not determinative when measuring fair value. The concept of a fair value measurement assumes an orderly transaction between market participants. An orderly transaction is one that involves market participants that are willing to transact and allows for adequate exposure to the market. Distressed or forced liquidation sales are not orderly transactions, and thus the fact that a transaction is distressed or forced should be considered when weighing the available evidence. Determining whether a particular transaction is forced or disorderly requires judgment.
Yes. A quoted market price in an active market for the identical asset is most representative of fair value and thus is required to be used (generally without adjustment). Transactions in inactive markets may be inputs when measuring fair value, but would likely not be determinative. If they are orderly, transactions should be considered in management's estimate of fair value. However, if prices in an inactive market do not reflect current prices for the same or similar assets, adjustments may be necessary to arrive at fair value.
A significant increase in the spread between the amount sellers are "asking" and the price that buyers are "bidding," or the presence of a relatively small number of "bidding" parties, are indicators that should be considered in determining whether a market is inactive. The determination of whether a market is active or not requires judgment.
In general, the greater the decline in value, the greater the period of time until anticipated recovery, and the longer the period of time that a decline has existed, the greater the level of evidence necessary to reach a conclusion that an other-than-temporary decline has not occurred.
Determining whether impairment is other-than-temporary is a matter that often requires the exercise of reasonable judgment based upon the specific facts and circumstances of each investment. This includes an assessment of the nature of the underlying investment (for example, whether the security is debt, equity or a hybrid) which may have an impact on a holder's ability to assess the probability of recovery.
Existing U.S. GAAP does not provide "bright lines" or "safe harbors" in making a judgment about other-than-temporary impairments. However, "rules of thumb" that consider the nature of the underlying investment can be useful tools for management and auditors in identifying securities that warrant a higher level of evaluation.
To assist in making this judgment, SAB Topic 5M1 provides a number of factors that should be considered. These factors are not all inclusive of the potential factors that may be considered individually, or in combination with other factors, when considering whether an other-than-temporary impairment exists. Factors to consider include the following:
The length of the time and the extent to which the market value has been less than cost;
The financial condition and near-term prospects of the issuer, including any specific events, which may influence the operations of the issuer such as changes in technology that impair the earnings potential of the investment or the discontinuation of a segment of the business that may affect the future earnings potential; or
The intent and ability of the holder to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in market value.
All available information should be considered in estimating the anticipated recovery period.
* * *
Finally, because fair value measurements and the assessment of impairment may require significant judgments, clear and transparent disclosures are critical to providing investors with an understanding of the judgments made by management. In addition to the disclosures required under existing U.S. GAAP, including Statement 157, the SEC's Division of Corporation Finance recently issued letters in March and September that are available on the SEC's Web site to provide real-time guidance for issuers to consider in enhancing the transparency of fair value measurements to investors. Additionally, the SEC staff and the FASB staff will continue to consult with capital market participants on issues encountered in the application of fair value measurements.
# # #
1 AU 332, Auditing Derivative Instruments, Hedging Activities, and Investments in Securities, of the PCAOB Interim Auditing Standards also provide factors to consider when evaluating whether an impairment is other-than-temporary.
“But when a company goes public, you and I can’t determine that there are no controls, or that fraud isn’t actually happening. That’s where SOX comes in.”
This certainly solves matters, by removing the incentive for an entire class of companies to go public.
Well, it could be resolved by rescinding SOX and the ability for stockholders to sue a company for fraud. If you are for that, then call your congressman.
thank you for your suggestion.
Are there other options available, or is this a binary choice?
ACORN showed its colors again in 1991, by taking over the House Banking Committee room for two days to protest efforts to scale back the CRA. Obama represented ACORN in the Buycks-Roberson v. Citibank Fed. Sav. Bank, 1994 suit against redlining. Most significant of all, ACORN was the driving force behind a 1995 regulatory revision pushed through by the Clinton Administration that greatly expanded the CRA and laid the groundwork for the Fannie Mae, Freddie Mac borne financial crisis we now confront. Barack Obama was the attorney representing ACORN in this effort. With this new authority, ACORN used its subsidiary, ACORN Housing, to promote subprime loans more aggressively.
http://travismonitor.blogspot.com/2008/09/manufactured-crises-and-leftwing-obama.html
The issue here is with so-called level 3 assets, derivatives and other thinly traded securities, private placements, etc, that require significant subjectivity and complex valuation models.
BUMP!!!
BTTT.
Thanks
A response from the accounting profession:
September 30, 2008
Dear Member of Congress:
The Center for Audit Quality (CAQ) believes that proposals advocating suspension of mark-to-market (or fair value) accounting are not in the best interest of investors or the capital markets and should be rejected.
The principles of mark-to-market accounting are rooted in the fundamental virtue of transparency and are central to informed market decisions and efficient allocation of capital. In our view, investor confidence would be undermined by efforts designed to mask the actual value of financial assets at a given point in time.
It is important to underscore that mark-to-market accounting has contributed positively to revelations about the severity of the economic crisis facing our country’s credit markets and certain institutions, but it did not create the economic crisis.
Recently, some have suggested that the Securities and Exchange Commission (Commission or SEC) or the Financial Accounting Standards Board (FASB) should suspend the application of mark-to-market or fair value accounting or somehow impose a moratorium on mark-to-market requirements for certain financial institutions when preparing financial statements to be used by investors.
Although determining fair values for financial instruments in an illiquid market can be challenging, the best estimate of the prices that would be received for such instruments in orderly transactions occurring at the measurement date remains the most relevant information for investors and policymakers. To lessen the uncertainties about the value of these securities, it is critical that investors continue to have the insight provided by the application of mark-to-market accounting principles.
Many of the current requirements stem from the Savings & Loan crisis in the 1980s, when we learned that not knowing the real, current values of financial instruments held by financial institutions can be devastating when the bubble finally bursts and institutions are forced to close their doors. The current requirements provide a uniform and consistent method to measure market values and provide investors increased disclosures about those measurements. Suspending mark-to-market accounting would throw financial reporting back to a time of less comparability, less consistency and less transparency.
If there are concerns with the impact of asset valuations on capital requirements of financial institutions, regulators have alternatives other than obscuring information relevant to investors. Regulators may modify those requirements based on criteria other than fair value accounting measurements to the extent they deem appropriate.
Other capital markets participants also have expressed concern about the lack of transparency that would be created by a suspension of mark-to-market accounting. The Council of Institutional Investors, which represents 130 public, corporate and union pension funds with combined assets of more than $3 trillion, stated in a recent letter to the SEC that “[a]ny termination or suspension of fair value accounting will lessen transparency and investor confidence in the capital markets at a time when such confidence is critical to the stability of our markets and the overall economy.”
Likewise, the CFA Institute, a global, professional association of more than 97,000 investment professionals with offices around the world, recently wrote to both members of Congress and the SEC and noted that “[c]easing fair value reporting will only serve to undermine the confidence of investors in our financial institutions and lead to a further crisis of confidence in our government and the regulatory bodies overseeing those institutions.”
The proposed Emergency Economic Stabilization Act of 2008 restates the authority of the Commission to suspend the application of Statement of Financial Accounting Standards No. 157, Fair Value Measurements (FAS 157), and requires that the Commission conduct a study on the effects of FAS 157 on financial institutions’ balance sheets, the impact of such accounting on bank failures in 2008, the quality of financial information available to investors, and other matters, and report its findings to Congress within 90 days. While a restatement of existing SEC authority and a study of mark-to-market accounting and its effects are not necessarily harmful in their own right, efforts to weaken the transparency provided by the current standard should be avoided, especially in this time of financial instability.
The CAQ would be pleased to discuss with you any of the points in this letter at your convenience.
Sincerely,
Cynthia M. Fornelli
Executive Director
Center for Audit Quality
Cc: Henry M. Paulson, Jr., Secretary, Department of Treasury
Ben S. Bernanke, Chairman, Federal Reserve
Christopher Cox, Chairman, SEC
Mark W. Olson, Chairman, PCAOB
Robert H. Herz, Chairman, FASB
All Members of Congress
The CAQ is an autonomous public policy organization serving investors, public company auditors and the capital markets and is affiliated with the American Institute of CPAs. The CAQ’s mission is to foster confidence in the audit process and to aid investors and the markets by advancing constructive suggestions for change rooted in the profession’s core values of integrity, objectivity, honesty and trust. Based in Washington, D.C., the CAQ consists of approximately 800 member firms that audit or are interested in auditing public companies.
Explanations from the AICPA:
AICPA Media Center — FAQs About Fair Value Accounting
Fair Value Basics Explained
* What is fair value accounting? Fair value accounting, also called “mark-to-market,” is a way to measure assets and liabilities that appear on a company’s balance sheet and income statement. Measuring companies’ assets and liabilities at fair value may affect their income statement. SFAS 157 was issued in 2006 by the Financial Accounting Standards Board (FASB) effective for fiscal year 2008. SFAS 157 defines in one place the meaning of “fair value.”
* Why is it important today? Huge losses reported by financial firms on subprime assets have led to a debate over the implementation of SFAS 157 in circumstances where markets collapse and price inputs aren’t readily available. In the current crisis, banks and investment banks have had to reduce the value of the mortgages and mortgage-backed securities to reflect current prices. Those prices declined severely with the collapse of credit markets as mortgage defaults escalated.
* What is FASB? FASB is the independent U.S. accounting standard-setting body based in Norwalk, Conn., that sets U.S. generally accepted accounting principles used by all U.S. publicly-traded companies. Bob Herz, chairman of FASB, gave a speech in New York last week discussing the performance of U.S. GAAP in this financial crisis.
* The AICPA supports the independent role of the FASB as the authoritative private-sector arbiter of U.S. accounting standards in the U.S.
* How does mark-to-market work? SFAS 157 provides a hierarchy of three levels of input data for determining the fair value of an asset or liability.
o Level 1 is quoted prices for identical items in active, liquid and visible markets such as stock exchanges.
o Level 2 is observable information for similar items in active or inactive markets, such as two similarly situated buildings in a downtown real estate market.
o Level 3 are unobservable inputs to be used in situations where markets don’t exist or are illiquid such as the present credit crisis. At this point fair market valuation becomes highly subjective.
* What does SFAS 157 apply to? The fair value accounting standard SFAS 157 applies to financial assets of all publicly-traded companies in the U.S. as of Nov. 15, 2007. It also applies to non-financial assets and liabilities that are recognized, or disclosed, at fair value on a recurring basis. Beginning in 2009, the standard will apply to other non-financial assets. SFAS 157 applies to items for which other accounting pronouncements require or permit fair value measurements except share-based payment transactions, such as stock option compensation.
* What is the AICPA’s role in this? The AICPA’s role is to make sure that our members stay informed and participate in the debate. The AICPA will seek to ensure our members are educated and have the necessary tools and knowledge to comply with current accounting standards on fair value. The AICPA has formed a Fair Value Resource Panel to identify highest-priority member needs in the area of fair value measurements and address issues in the long-run by providing detailed implementation guidance in the future. The AICPA is an observer at the FASB valuation group.
Fair Value Technical Explanation
What are the three pricing input levels?
* The term inputs is used in SFAS 157 and is used in applying various valuation techniques (approaches). Inputs refer broadly to the assumptions that market participants would use in pricing the asset or liability, including assumptions about risk.
* To increase consistency and comparability in fair value measurements and related disclosures, SFAS 157 created a fair value hierarchy. The hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels.
* The fair value hierarchy gives the highest priority to quoted prices (unadjusted) in active markets for identical assets or liabilities (Level 1), and the lowest priority to unobservable inputs (Level 3).
What is the definition of Level 1 inputs?
Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. An active market for the asset or liability is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available.
What is the definition of Level 2 inputs?
Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. If the asset or liability has a specified (contractual) term, a Level 2 input must be observable for substantially the full term of the asset or liability. Level 2 inputs would include, for example, quoted prices for similar assets or liabilities.
What is the definition of Level 3 inputs?
Level 3 inputs are unobservable inputs for the asset or liability. Unobservable inputs should be used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date. However, the fair value measurement objective should remain the same; that is, an exit price from the perspective of a market participant that holds the asset or owes the liability.
Unobservable inputs should be developed based on the best information available in the circumstances, which might include the reporting entity’s own data. In developing unobservable inputs, the reporting entity need not undertake all possible efforts to obtain information about market participant assumptions. However, the reporting entity shall not ignore information about market participant assumptions that is reasonably available without undue cost and effort. Therefore, the reporting entity’s own data used to develop unobservable inputs should be adjusted if information is reasonably available without undue cost and effort that indicates that market participants would use different assumptions.
Links to Additional Resources:
A list of resources available from the AICPA can be found at http://fvs.aicpa.org/Resources/Fair+Value+for+Financial+Reporting/
FASB’s explanation of SFAS 157 can be found at http://www.fasb.org/st/summary/stsum157.shtml
Information about FASB Valuation Resource Group can be found at http://www.fasb.org/project/valuation_resource_group.shtml
The Securities and Exchange Commission’s announcement and additional guidance: http://sec.gov/news/press/2008/2008-234.htm
http://www.sec.gov/divisions/corpfin/guidance/fairvalueltr0908.htm - Dear CFO letter from Sept. 2008
http://www.sec.gov/divisions/corpfin/guidance/fairvalueltr0308.htm - Dear CFO letter form March 2008
The text of Bob Herz’s Sept. 22 speech in New York is available at: http://www.fasb.org/news/09-18-08_herz_speech.pdf
The AICPA’s Center for Audit Quality letter to Congress and the SEC: http://www.thecaq.org/
Views of the Council of Institutional Investors are here: http://www.cii.org/UserFiles/file/press%20release%20on%20bailout%20FINAL%20(2)%2009-23-08.pdf
Positions of the CFA Institute can be found here: http://www.cfainstitute.org/centre/topics/reporting/official/fair_value_reporting.html
A list of resources available from the AICPA can be found at http://fvs.aicpa.org/Resources/Fair+Value+for+Financial+Reporting/
......anyway to find out what this really means.....
Higher taxes
Maybe I’m missing your point. Aren’t MBS individual mortgages bundled together?
A mortgage-backed security is supported by the cash flow generated by a pool of tranches (slices) of individual mortgages.
One mortgage can be sliced and diced into many pieces, with each piece in a different mortgage-backed security.
Bundling mortgages into a mortgage-backed security (or multiple mortgage-backed securities) is completely different from selling the mortgage loan as a whole piece.
The idea is that, while some mortgages may have high risk (such as subprimes originated so illegals can buy a house), others (like yours) might not. And, if you bundle them in certain ways, you can reduce the overall risk of the pool of slices of mortgages to a more palatable level.
Of course, all sorts of derivative securities (interest rate swaps, credit-default swaps, etc.) were attached to these mortgage-backed securities, so when the mortgage-backed securities start to blow, possibly due to defaults caused by ARM rate and payment resets, the derivatives follow.
It should prove educational for you (and us all) to read the 300+ page Senate bailout bill today, and remember it came from a committee much as Sarbanes-Oxley came from committee! and remember as well that a camel is a horse designed by committee.
Couldn't get thru the first line without the BS Meter pegging....Where there is NO market...where is the transparent 'valuation'? nope, the principles of mark-to-market were rooted in Enron "payback" mentality...last I checked, Enron wasn't a bank.
...and more bureaucrats. Sarb-Ox, and M2M are bureaucracy welfare programs...and will slowly bleed the competitiveness out of the USA. Succeeding where the Kyoto treaty failed.
Accounting for assets on a historical basis or some really stupid 3 year average idea that Newt threw out ignores the reality that a company lost money. Doing a reality check that compares the current value and taking losses if the value decreases makes sense. Enron has nothing to do with the logic.
Playing games with accounting methods in order to hide the losses is not the way to fix this problem. If anything, FASB 157 forced our current problems to come to light instead now instead of 1 or 2 years when the damage is far greater.
What IS it with these people! That little kernal of info - put out by McCain's Policy Advisor could have been made much earlier and framed on Drudge Report as well. (Seems they do not even read it; if their surprise of Gwen Ifill is correct.)
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