Not fair game to attack accounting for Global Financial Crisis

GLOBAL FINANCIAL CRISIS – Fair value accounting has received a lot of blame as the cause of the current financial crisis, not least by politicians.

The problem is that they clearly do not fully understand the operations of the market. The danger is that they have the power to interfere in accounting rules. They must not do this. 

Fair value accounting does not bring about increased volatility or make markets illiquid. Politicians’ misunderstanding of this may be deliberate, since changing the rules may serve to cover up the extent of the problems.

But covering them up will not resolve them. The banks, not accounting, caused the crisis, ultimately through bad lending.

Accounting rules are designed to reveal the full extent of losses and future risks. The transparency we have means the banks, regulators and governments can begin to put matters right by identifying the specific causes of the crisis. As well as bad lending, these included poor risk management and overreliance on rating agencies, complex problems requiring detailed analysis. Shooting the messenger will not help.

Granted, fair value accounting is not easy in inactive or illiquid markets where prices are not easily available. Accounting rulemakers are right to insist on some link with market prices, if these valuations are to have any objective value. But it still leaves banks, regulators and investors with practical problems related to expertise, resources and methodology.

These must be addressed and standard setters are on the case. But their job is complicated by politics, particularly the ploy that linked accounting with financial stability at the November G20 meeting in Washington.

In its communiqué, the G20 concluded: “With a view toward promoting financial stability, the governance of the international standard-setting body should be further enhanced, including by undertaking a review of its membership, in particular to ensure transparency, accountability and an appropriate relationship between this independent body and the relevant authorities.”

There is no agreed definition of financial stability, except perhaps to identify it with the stability of the banking system, itself sometimes defined simply as the lack of collapsing banks.

The statement is vague, but it does allow for potential conflicts between transparency and financial stability. If the latter became the overriding objective for the standard-setting bodies, then transparency could be set aside to halt wholesale panic.

The International Accounting Standards Board should also be “accountable”, a word indicating responsibility and beloved by politicians. They hope that no one will ask the questions: to whom and for what?

What exactly is the “appropriate relationship” between the IASB and the relevant authorities? It could mean that the standard setter should subsume its requirements in groups with responsibility for maintaining the banking system, such as the UK Financial Services Authority, France’s Commission Bancaire and the US Federal Reserve.

Sir David Tweedie, chairman of the IASB, interprets it as working together with prudent regulators to enhance their work by providing better measurements of the quality and quantity of a bank’s true position and for better assessments of its risk management. That relationship is already under way and is a smart move.

Whatever the purpose of the G20 statement, the result on accounting is to risk confusion about the role of the international standard setter and to undermine its independence.

The real question to be addressed is: how can confidence in banks be maintained? Proper accounting standards and sound auditing can provide support for that confidence. The only role the IASB has, and should have, in this is to set accounting standards, free from outside pressure, with which the banks must comply.

Oonagh McDonald is an international consultant on financial regulation and a former director of the FSA