Ewald Müller
23 October 2008
opinion
Johannesburg — UNSURPRISINGLY, fingers are being pointed in all directions as people try to identify a scapegoat in the global financial meltdown.
Among several prime suspects are the accountants because, so the argument goes, it is they who have foisted International Financial Reporting Systems (IFRS) on the global financial infrastructure. In particular, because IFRS insists that all assets be fairly valued - a requirement that has decimated balance sheets across the world, undermining confidence and sparking all manner of crises in the process.
The starting point is the accounting rule that was put in place during the past 15 years by, variously, the US Financial Accounting Standards Board (FASB), the Securities and Exchange Commission and the International Accounting Standards Board. The fair value accounting rule dictates that all companies, including financial institutions holding financial instruments available for sale, must mark those assets to market. There's nothing wrong with that, but how should such assets be valued when the already thin market for those assets freezes up and only a handful of transactions occur at depressed prices?
A prominent US commentator recently urged: "When there are temporary impairments of asset values due to economic and marketplace events, regulators must give institutions an opportunity to survive the temporary impairment. Assets should not be marked to unrealistic fire-sale prices. Regulators must evaluate the assets on the basis of their true economic value." Such a stance is superficially fair and reasonable; yet it is flawed in its assumptions that:
JPMorgan has been quick to point out that blaming fair value accounting for the credit crisis is like going to a doctor for a diagnosis and then blaming him for telling you that you are sick.
None other than the FASB has been forthright in pointing out that 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 which include appropriate risk premiums, is perfectly acceptable.
"The determination of fair value often requires significant judgment," the FASB acknowledges. "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." Accordingly, the accountants have manifestly provided more than adequately for value right across the board. The pointed fingers in this direction are clearly misdirected.
IFRS did not force people to buy things they couldn't sell. That lenders have been exposing their balance sheets to undue risk that they did not fully understand is not the fault of IFRS. The fault lies with the people making the decisions to assume those risks.
We need to ask why those instruments were being held. Don't beat up IFRS because the instrument must be valued. Ask why the instrument was bought if it could not be realistically valued. It is management of whom the question should be asked, not the accountants.
The debate would not be complete without mentioning the role that securitisation, which is the process of converting assets, often illiquid ones, into more liquid, tradable securities, has played in worsening the crisis. It is certainly no secret that SA has enjoyed an effective buffer against the credit crisis through prudent lending policies and an aversion to large-scale and reckless securitisation schemes involving illiquid assets.
In contrast, a feature of the US financial markets has been the complexity of the securitisation structures, such that many lenders' traditional responsibilities were parcelled out to separate and disparate stakeholders. The practice grew to such an extent that eventually the system was unable to manage it.
If blame for irresponsible securitisation is to be apportioned, much can be assigned to regulators and to each party to the structure. Again, this is not a flaw in the system that can be assigned to the accountants. Indeed, it is the accountants who are right now trying to pinpoint the role played by each stakeholder in the process with a view to determining the changes that are needed.
Müller is senior executive: standards at the South African Institute of Chartered Accountants.
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