The exacerbation of the credit crisis had less to do with accounting and more to do with “trying to describe a binary event with a probabilistic model,” contended Wiseman Nkuhluk, chairman of the audit committee for AngloGold Ashanti, and former economic advisor to the president of the Republic of South Africa. Consider the credit default swap market, he says by way of example.
If a CDS seller understood the high risk that a rapidly sinking market put on the swap, it would have been priced into the instrument. But CDSs were not priced taking into account a risk like the blow-up of the subprime mortgage market. An unusual event like the subprime crisis rendered market information useless, says Nkuhluk. “[Going forward] our challenge will how to understand that the future is a probabilistic model.”
For his part, former U.S. Securities and Exchange Commission chairman and FCAG cochair Harvey Goldschmid said that the group had reached something of a consensus about keeping fair value accounting, but working to improve it. The former chairman of Deutsche Securities, Toru Hashimoto, reinforced Goldschmid’s comments, saying that while he thought that factors like greed, excess liquidity, and poor risk management contributed to the financial crisis more than flawed accounting rules did, he still thinks that fair-value accounting played a part in the crisis.
On the positive side, fair-value accounting was important for identifying problems in the early stage of the crisis as assets values had to be marked down, said Hashimoto. However, fair value accounting also may have supported the buildup of the asset price bubble, and allowed the creation of the bubble without underscoring the risk behind it, reasons the former executive. “When there is a lot of profit building up, [it is also likely that] risk is building up and may materialize in the future,” he said. That is why Hashimoto would like to see a “dynamic provision” added to either accounting rules or banking regulations, so in good times reserves can be built up, and then drawn upon in a downturn.