Fair Value is Fair Value

"Everything secret degenerates, even the administration of justice; nothing is safe that does not show how it can bear discussion and publicity." - Lord Acton

The accounting standard known as FAS 157, otherwise known as mark-to-market accounting (see How Mark To Market Turned Mr. Market Into Mr Magoo for detail on how it works), has been criticized by some bankers, notably Blackstone Group chief Steve Schwarzman, for needlessly causing big write-downs and encouraging financial panic. It's defenders include Goldman Sachs, which pointedly left the Institute for International Finance in June, a banking lobby group, over the IIF's anti-mark-to-market stance. Last week Treasury Secretary Hank Paulson defended mark-to-market during a talk he gave at the New York Public Library (which, ironically, is now officially called The Stephen A. Schwarzman Library.)

"I believe in fair value accounting," Paulson reportedly said. Robert Teitelman writes in The Deal that Paulson offered up a spirited defense of mark-to-market accounting, also known as "fair-value accounting." Paulson made several points. First, we can't just throw "fair-value" accounting out the window because of some illiquid markets in a crisis. Second, you can't run an investment bank without mark-to-market. Third, we need to recognize the losses and move on. Fourth (Teitelman made this one up), "stop whining you damn crybabies".

Teitelman's fourth point is interesting and applicable in REIT land, and I quote liberally from his article as a result (if not already blessed with eternal life, my 6th grade writing teacher soon will be after reading this weak attribution. Apologies in advance Ms. Graham!).

Now maybe our Treasury chief is right, Teitelman writes, particularly on point four. But no one is saying -- well, hardly anyone -- that we should just toss out mark-to-market, giving the banks a fat break and move on. The question is more subtle than that: Does mark-to-market need to be applied universally, to all assets classes and financial instruments? Is the prudent duration for all assets a short-term market standard, or just for some? And do the standards or indices we now have work in illiquid markets under stress, or are they prone to failure or manipulation?

Moreover, the entire financial world does not consist of investment banks. There are insurers out there, retail banks, private equity shops, money managers. There is a whole diversity of financial providers that we are trying to jam through the keyhole of mark-to-market accounting. And, yes, given that investment banks make their money (or lose it) in short-term markets every day, it is completely appropriate to apply strict mark-to-market to them.

The fact is, mark-to-market is completely appropriate to any speculative enterprise. The spread of mark-to-market to all corners of the financial world represents not only a blurring of the once-bright line between investment and speculation, but its obliteration. Speculation has won. And the notion that the best snapshot of reality is the one hatched by the markets every day has won. And FASB 159, an extension of FAS 157, is also completely appropriate as well. Sure speculators can speculate, but others can speculate againsts those speculators (by repurchasing their own marked-down debt, for example, as NRF and GKK have done). And as a result of all this, individual investors are less susceptible to to opaque disclosures and smoky, back room deals.

For individual investors, that triumph not only brings opportunity, but also gut-wrenching, bottle-draining stress as the "daily demands of traders and activists" are digested by the second into one's individual net worth.

As Tietelman writes however, fair value, is, of course, by definition, fair. And who can argue with that?