FASB Fair-Value Proposal Fights Sticky Wicket

In its just-issued staff proposal, the board would steer bondholders away from valuing their holdings according to scattered market sales.

Fighting an apparently uphill battle against a reading of its fair-value measurement standard that has mistakenly led to fire-sale asset pricing, the Financial Accounting Standards Board on Tuesday night proposed new guidance on mark-to-market accounting.

The proposed guidance would come, if it’s approved after a comment period ending on April, in the form of two FASB staff positions. One would guide asset holders who mark their holdings to market through a two-step process to help them decide “whether a market for a financial asset that historically was active is not active and whether a transaction is not distressed.”

The proposal addresses situations in which an asset once valued according to transactions in an active market might have to value the asset by using a theoretical pricing model. Among the conditions in which “mark-to-model” valuation applies are illiquid markets and sales made under the duress of pricing pressure.

The second FASB staff position would provide asset holders with guidance on how to account for securities losses on “Other-Than-Temporary Impairments.” Issuers must record losses on such assets, which holders either can’t or won’t hold to maturity, at fair value.  If both proposals are approved, they would be effective for interim and annual periods ending after March 15, 2009.

Pressured by members of Congress and by banks who have claimed that its rules have helped spawn the current banking meltdown, FASB is acting with almost unprecedented speed to make the two staff positions official. If the staff positions are enacted on April 2, it would be only slightly slower than the speed with which FASB and the Securities and Exchange Commission enacted earlier fair-value guidance last October after a mere 10-day comment period.

The staff positions, particularly the first one, are aimed at breaking the grip management and auditors have on the use of data based on the last available asset sale, according to David Larsen, a Duff & Phelps managing director and a member of FASB’s Valuation Resource Group. Speaking at a D&P press briefing on Wednesday, he referred to the issue as “stickiness” in the use of observable data in fair-value measurement.

Under FAS 157, the board’s standard on fair-value measurements, holders of financial assets recorded in fair-value must report on how they came up with their values. They must classify the measurements into three levels of assumptions, depending on how “observable” the information is. In level 1, the value of an asset or liability stems from a quoted price in an active market. In level 2, it’s based on “observable market data” other than a quoted market price.

In level 3, which often applies to asset valuations in illiquid markets or in “distressed” sales (sometimes called “fire sales”), fair value can be determined only through “unobservable inputs” and prices that could be based on internal models or estimates.

Many FASB constituents, however, mistakenly use “an observable market transaction even when that transaction may be distressed or the market for that transaction may not be active,” according to the staff proposal.

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