The SEC’s new accounting clarifications assert that whenever assets are temporarily impaired or their values are distressed — whatever that means — market prices might be unrepresentative estimates of value.
In such cases, the new clarifications allow for nonmarket, “mark‐to‐model” methods — the very methods employed by Enron — to be used for fair value accounting. With its embrace of nonmarket valuation methods, the SEC has entered the twilight zone.
And the SEC is not alone. Under heavy lobbying from major banks and European politicians — notably French President Nicolas Sarkozy — the Expert Advisory Panel of the International Accounting Standards Board made its recommendations on Oct. 10, and they were endorsed by the IASB.
Under the new IASB rules, it will become easier for companies to throw current market prices to the winds and replace them with values based on amortized costs.
The recent failures of some financial firms have given new life to arguments against the use of market prices, or mark‐to‐market accounting (MTM). Critics claim that firms with assets under price pressure face losses that deplete their capital and increase their risk of insolvency.
Such firms are forced to shrink by selling assets, but these sales can spark further asset price declines and capital losses, requiring further sales. At every stage, critics argue, firms are pushed toward insolvency by MTM. According to the critics of MTM, the bogeymen of the current crisis are market prices.
MTM rests on two principles: the social value of market prices and the role of accounting information. First, an asset is only worth its price in the marketplace, which is the only objective measure of value. Second, accounting statements must provide accurate and meaningful information. Investors have a right to accurate and actionable information on the value of their corporate assets.