Thursday, April 2, 2009

Financial Accounting Standards Board (FASB)

FASB is an industry based policy board that sets accounting protocol for corporations. The Securities and Exchange Commission (SEC) officially recognizes FASB as the private sector authority in setting these rules. Although the SEC has the authority to set the rules itself, it has decided that the private sector alternative allows for a more responsive and informed process.

FASB is in the news today because they have decided to modify SFAS 157. This statement contains the guidelines for fair value measurements of assets. The changes facilitate the relabeling of certain assets and facilitate the prorating of potential losses on holdings.

This is important to financial companies in particular because the trend up until this point has been to promote balance sheet transparency. So, bank stocks are moving higher today because there is less fear about recording large losses than there was yesterday.

Has the landscape truly changed though? Home price are still sliding, hundreds of thousands of Americans are still losing their jobs each month and federal government crowding out is doing as much harm to the private sector as the tightfisted banks are doing.

Please, buy with extreme caution.


buchlajoe said...

I have a question , when were the mark to market rules instated? how long have they been in place?
thank you

MK said...

SFAS 157 goes back to 2006. As is typical with these statements, corporations were given lead time to prepare for the changes. The original implementation date was, I believe, the 4th quarter of 2007. However, I think it was postponed until early 2008.

There are two major concerns when marking to market: asset category and nature of impairment. FASB allows for three categories of assets:

Level I assets are those whose prices are easily observable. Listed and NASDAQ equities, Treasury Bonds, even GSE debt and most corporate debt would fall into this category. There would be no debate when arriving at a mark for these assets.

Level III assets are those whose prices are unobservable. There is no consistent market or exchange or even an industry convention when it comes to pricing. Commonly referred to as "mark to model" assets, pricing is actually up to the asset holders. If XYZ Corp. holds Level III assets, then XYZ Corp. prices their own Level III assets.

Level II assets are somewhere in between. There may be a consensus pricing method, but trades may be infrequent.

Anticipated length of impairment refers to how long the asset holder anticipates the instrument will trade at a discounted price. If the holder intend to own the security to maturity, then the rules for marking to market are relaxed.

Today's FASB actions made it easier for companies to move assets from Level II status to Level III and eased the language used to describe asset impairment.

This leads to a few questions:

Why would a bank own assets that can't be priced in the first place?

How do you know what a temporary impairment is?

buchlajoe said...

Thanks for clearing this up for me!