Layer Cake Regulation

Story Highlights:

• Mark-to-market and fair-value accounting were widely thought to have exacerbated problems during 2008's financial crisis.
• In response, the government mandated the Securities and Exchange Commission provide a study on mark-to-market accounting and FAS 157.
• The SEC provided a 211-page report to Congress on December 30th. The basic message of the report: The SEC does not recommend suspending fair-value accounting rules, instead suggesting "improvements."
• New rules on top of already debatable rules only add to complexity and perhaps brew other problems down the line. What accounting standards need is clarity.

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The holidays are over and prudently, it's time to diet. January is the year's biggest month for new gym memberships and for at least a couple weeks, Americans will be focused on working off those extra holiday calories. It'll be elbow to elbow at the gym, but the government seemingly knows no such discipline—instead, it appears keen on packing on the pounds.

In October, Congress tasked the Securities and Exchange Commission (SEC) to provide a study on mark-to-market accounting and FAS 157 (after critics ardently claimed these rules contributed to spiraling write-downs and asset sales during the financial crisis). Well, the SEC delivered on December 30th—in a report no less than 211 pages thick. The basic message? The SEC doesn't recommend suspending fair-value accounting rules, instead suggesting "improvements" to deal with illiquid markets and reducing the number of models used to measure asset impairment.

To us, this is the oldest recipe in the US regulatory book—to complicate faulty rules by adding new layers of rules. The SEC reasoned an abrupt end to fair value and market-to-market requirements would take away transparency and "erode investor confidence." Call us crazy, but the extinction of all major independent investment banks in the matter of months tied to writing down the values of illiquid debt securities seems quite a bit more abrupt than suspending the rule. What's more, new rules on top of already debatable rules only add to complexity and perhaps brews more problems down the line.

For example, the report says the "key principle to the exchange price is an orderly transaction which allows for due diligence and is not from a distressed sale or forced transaction." But this raises the question of what constitutes "distressed" or "forced." And who will decide? Though lengthy, the SEC's report failed to provide meaningful answers and specific action plans, suggesting investors, firms, and auditors may have to do double duty to figure it all out.

We've mentioned before the US regulatory system is too convoluted—it's no less true for the regulations themselves. It's no small irony the SEC generated this report—though they aren't even the ones who created the rule! (The Financial Accounting Standards Board, or FASB, did.) The SEC reported fair-value accounting didn't appear to play a meaningful role in 2008's bank failures, but that seems hard for us to accept based on our own analysis.

It's a pity many of today's solutions simply add new layers of restrictions to existing rules rather than trying to root out principal causes. What accounting standards need is clarity—not another layer of empty calories.