Defending Fair Value

Executives of financial institutions have been critical of fair value measurement in accounting. The standard setters are listening to these calls as can be seen in the announcement of FASB relaxing the requirements to write down impaired assets measured at fair value.

Weakening the rules on fair value measurement is a disservice to users of financial statements and destabilises financial markets. If users are kept in the dark about the magnitude of the losses then they will assume the worst - the law of adverse selection. Decisions made on less than the fullest information available are more likely to prove to be poor decisions in hindsight. Not only will this harm the individual decision maker but it will harm society by preventing the market from delivering the optimum distribution of resources.

Blaming accounting rules for their own mismanagement merely highlights that the views of the scoundrels managing some financial institutions are not worthy of consideration. There is nothing in the accounting which forced management to invest imprudently. The sincerity of these critics of fair value can be challenged if they did not criticise fair value measurement when rising asset prices was leading to the booking of profits (resulting in bonuses for management).

Managers of financial institutions have chosen to invest in instruments with volatile market values. The accounting reports should report on that volatility to allow users to properly assess risks. Refusing to report the losses in fair value prevents users from fully assessing the risks. The accounting reports should not allow managers to hide their ineptitude.

To misquote Samuel Johnson: blaming accounting is the last refuge of the scoundrel.