What a blast from the past. FASB is finally issuing new guidance about market-to-market accounting rules after much finger pointing from both the Congress and the Wall St wonks. Almost a year ago, there was a big furor by Blackstone’s Schwartzman about the potential dangers of FAS 157 and the blogosphere debated about it pretty extensively. A recap – FAS 157 forces companies to value their assets to the price the market is willing to pay and not the actual cash flows that are generated by the asset. So if you hold a complex derivative product which has a intrinsic value of $100, but the market is willing to pay only $10, you take a $90 loss. So a mortgage backed security which is not subprime could be sound fundamentally but because the market is wary of these securities, you have to mark them down on your balance sheet. I did a presentation last year (link below) on how companies could benefit themselves by using a loophole in market-to-market valuation. I don’t pretend to be an oracle on financial matters, but I do remember sending a pretty clear message to my class that fair-value will burn most balance sheets as the market cools down.

While most of the financial industry is mad at FASB for FAS 157, do remember that it is not mandatory. What everyone forgets is that back in the heyday when all was good and valuations were sky high, most of the firms chose mark-to-market because they could mark up their assets and create income from thin air. When the market is suddenly illiquid, the same hawks are trying to blame the accounting rule. When securities are based on complex models and are comprised of diverse securities, it is almost impossible to factor all the risks comprehensively; yes, they can calculate alphas, betas, gammas and thetas, but how do you model the risk of illiquidity. These securities should never have been classified as mark-to-market in the first place. At this time, because of the immense illiquidity in the market, a relaxation of the 157 might be justified, but I am wary as to whether this will set a precedent for further opacity in asset valuations. Unfortunately there is no middle ground and FASB should not be the one to blame; the rule as it is, is more than fair even if not precise in its guidance.