The big bad accounting - "fair values"?

Does fair value accounting prescribed by US GAAP and IFRS lead to bankruptcy?

In today's Wall Street Journal there is an article entitled Bad Accounting Rules helped Sink AIG by Zachary Karabell.

This follows on from my post yesterday on the IASB responses to the credit crisis.

To summarize the arguments Mr Karabell believes that the "fair"values prescibed by GAAP are an overkill.

The current meltdown isn't the result of too much regulation or too little. The root cause is bad regulation, he says

A few years from now, there will be a magazine cover with someone we've never heard of who bought all of those mortgages and derivatives for next to nothing on the correct assumption that they were indeed worth quite a bit.

It is a very interesting article which does acknowledge the complexity of the question and the situation at AIG that apparently included layers of derivatives. Yes the valuation methodology needs a review but should we abandon fair value accounting entirely?

What is the solution? Go back to some historical cost model with write down for individual impairment (a mixed value model). Even under such a model surely one would need to at least disclose the "current value" of the derivatives? Derivatives can be your friend but can be "weapons of mass financial destruction" (I heard that saying a few days ago but I did not get the attribution - perhaps someone can set me straight). How will we hold management accountable if we do not have the discipline of fair value accounting? I wonder if there would be complaints if fair values had increased - more bonuses?

The biggest factor in a financial business is confidence. Once confidence is lost nobody will do business with the institution. Changing the accounting scorecard will not help. What if assets are valued on a cost basis and a company is forced to liquidate then a lot of questions would be asked concerning overstatement of assets when there is a "fire sale". It's heads you lose tails you lose!

Do not look to accounting alone to solve the situation we need to look to a lot of different factors. The report of the Financial Stability Forum cited in yesterday's post covered many other considerations in managing the credit crisis.

The SEC held a Roundtable on fair value accounting during the summer that I reported on in this blog. A variety of opinions were expressed but this was of course before the current problems of the last week or so. The FASB is holding a webcast on Application of Statement No. 157, Fair Value Measurements
on September free for all to register.

Also don't forget to read the IASB draft on valuation in illiquid markets that I referred to yesterday. There is a tight deadline for comments on that document.

I continue to follow what I call "The Fair Value" game. Perhaps it's "The Fair Value Nightmare"?