Discussion of Mark-to-Market standards for Investment securities

Relevance vs. Reliability – “Going back to the basics”
In a recent Wall Street Journal article titled “A Scion Drives Toyota Back to Basics”, Toyota’s incoming president, Akio Toyoda, said that the company his grandfather founded 72 years ago has become too fancy for its own good. Mr. Toyoda maintains kakushin, or “revolutionary change”, spawns technological innovation that comes at a cost. His conclusion is that these increased production costs have led Toyota astray from its core ideas of thrift and efficiency. Consequently, Mr. Toyoda has called for a return to these core beliefs by going back to the basics.
The basics of accounting are relevance and reliability. In a perfect world, asset valuation would always be equally relevant and reliable. The real world, however, requires accountants to choose between the two. Traditionally conservatism, which favors reliability over relevance, has won out. That is until recently when some kakushin hungry accountants decided this is the right time for a “revolutionary change” in financial reporting standards. Newly adopted FMV, or mark-to-market, requirements are evidence of this fundamental shift. Unfortunately, this departure from reliability to relevance could not have come at a worse time. The current credit crisis has brought these two principles to a dangerous crossroads where, like Aiko Toyoda, it is now the responsibility of the SEC, AICPA, and FASB to step in and go back to the basics by re-establishing a conservative attitude that favors reliability over relevance.

Fundamental motivation for adoption - Greed
When the markets were extremely liquid and robust this push for kakushi, towards relevant valuation of investment securities, initially came specifically from two massive market players; the public accounting and financial management/banking sectors. Now that these same markets have soured, the silence of many large public accounting firms regarding the value of newly imposed relevancy-focused, mark-to-market, standards speaks volumes. While the public accounting industry stands quietly on the sidelines, their financially-based clients are speaking out. Not surprisingly, last November the ABA came out and officially announced their opposition of mark-to-market rules. This short sighted perspective and position from most public accounting firms represents an obvious potential windfall of profits. However, it will most likely come at a cost, because as the market contracts and more businesses go bankrupt their client pool will dwindle. While these negative outcomes may be temporarily postponed, they will eventually become yet another example of one industry biting the hand of another industry that feeds it. Eerily similar to what is currently occurring between the housing, mortgage, and investment industries.

Relevance – At what cost?
Mr. Dodd is not alone in his recent observation that some mark-to-market rules may need to be “tweaked”. A BusinessWeek article titled “EU eases mark-to-market rules” explains how the European Commission decided to “tweak” IFRS mark-to-market rules last October. European banks to were allowed to reclassify Level Three, or “toxic assets” like Mortgage Backed Securities, from “held-for-trading“ to “held-to-maturity”.
While these tweaks may be beneficial in the short-term, they unfortunately do not address the root problem when it comes to mark-to-market accounting, the overall cost of relevance. Outside of the obvious implementation costs facing companies, FMV accounting moves volatility from where it belongs, on “The Street”, to the balance sheet. Accounting should serve as the reliable bedrock on which innovation and the act of “creative destruction” is built. While having relevant information is important, first and foremost financial statements should reliable. The quest for offering predictive value via financial statements needs to be sacrificed in favor of predictability. Although it is obviously not ideal, volatile economic times, where bubbles balloon and burst, requires reliably irrelevant data versus unreliably relevant data. To reiterate, the primary purpose of accounting is to record and report events; not speculate on asset valuation. Speculators (investors) make money by reading between the lines of reliably irrelevant financial statements. Accountants are not currently equipped, or educated, to accurately value most sophisticated investment vehicles. Valuation should therefore be left where it belongs in the hands, and wallets, of speculators and investors who are willing and able to put their money where their mouths are.