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Writing in the American Spectator, Yingling in his title claims, “Improve Accounting Standards, Improve the Economy.” While accounting has deficiencies, I believe that his title and indeed his article greatly exaggerates the situation. The recession has been caused by the greed and the incompetence of bankers in the subprime markets, the ill-conceived securitizations that passed on hidden risks to investors, the foolish derivatives created with unknown risks to their creators, and the concomitant lies told in financial reports. Yingling begins with the usual bug-a-boo: “Mark-to-market accounting is contributing to uncertainty in the markets…” The truth is mark-to-market accounting is revealing the uncertainty in the markets. Without these fair values, some investors, most regulators, and all members of Congress would not have a clue to the up-and-down nature of risky securitizations and speculative derivatives. With these fair value measurements—however rough the estimates—investors and regulators and members of Congress have some insight into what managers are up to. Yingling asserts that “overly strict application of mark-to-market made the crisis much worse by creating a downward spiral of valuations based on prices in dysfunctional markets.” This proposition is incorrect for two reasons. First, the FASB does not require the use of market prices when markets become dysfunctional. It allows firms to employ Level 3 estimates that rely upon present value and other models if they provide better estimates. I suggest Yingling actually read FAS 157 so he can better understand what it says. Second, other factors were at play to cause the downward spiral of prices, including banks’ refusing to extend loans to other banks, refusing to purchase low-quality investments from other banks, and refusing to participate in risky securitizations. Instead of causing or even contributing to the economic decline, fair value accounting did its job by supplying various users with the information they needed to assess risky loans, low-quality investments, and questionable securitizations. It was the risky loans, low-quality investments, and questionable securitization that led to the downward spiral, not the information that revealed the truth. Yingling attempts to bolster his argument by saying that Congress “recognized the need to replace mark-to-market accounting.” Congress has not passed any legislation, so the recognition took place only for a few members of Congress. The statement that there has been “unprecedented debate among legislators” is untrue. Every time good accounting principles threaten managers with a requirement to reveal some truth that managers would prefer to hide, there is an “unprecedented debate.” Just ask Christopher Cox who, when a representative from California, sponsored several pieces of legislation for corporations to do away with threatening accounting, as long as the firms provided sufficient contributions to his campaign fund. Yingling goes on to state that the “lending and investment model of banks is based on cash flows rather than market value.” What does this statement mean? Market values are merely discounted future cash flows, so how can he distinguish them so cavalierly?
Chang Joon Song. “An Evaluation of FAS 159 Fair Value Option: Evidence from the Banking Industry.” <http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1279502>. This essay reflects the opinion of the author and not necessarily the opinion of The Pennsylvania State University.
Return to The Accounting Cycle J. EDWARD KETZ is accounting professor at The Pennsylvania State University. Dr. Ketz's teaching and research interests focus on financial accounting, accounting information systems, and accounting ethics. He is the author of Hidden Financial Risk, which explores the causes of recent accounting scandals. He also has edited Accounting Ethics, a four-volume set that explores ethical thought in accounting since the Great Depression and across several countries. He is the co-author of a monograph, Fair Value Measurements: Valuation Principles and Auditing Techniques (with Mark Zyla, Managing Director, Acuitas, Inc.) published by BNA in 2007. 2009 SmartPros Ltd. All Rights Reserved. Editorial and opinion content does not represent the opinions or beliefs of SmartPros Ltd. |
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