A Comment on SFAS 159

I am ambivalent about fair value accounting standards because they ruin comparability of financial statements across companies.  Recently, SFAS 159 has come into the news because some securities firms used it to book gains because the market value of debt that they issued had fallen.  Four notes:

1) They had no choice, they had to do it.  Their debt has liquid markets — those are level 1 and at worst level 2  liabilities.

2) Many of the assets that they carry have credit risk also.  The pressures that are leading the prices of their debt to fall, are also causing the carrying value of some of their assets to fall as well.

3) If credit markets for their debt improve, they will have to write those liabilities up to higher values.  Even if creditworthiness stays the same, the passage of time will make the liabilities rises in value as they get closer to the ultimate payoff.

4) In bankruptcy, their obligation to pay par does not change.  It is not as if they can pay the reduced market  value to pay off their debt, except through a deal agreed to by the court and plaintiffs.

Look, I don’t like the confusion SFAS 159 creates at this point any more than the next guy, but the gains here will likely reverse over time, absent bankruptcy.  As an analyst, I strip those gains out of income, and I should strip out losses on the asset side that I think will reverse as well.

We can change the way that gains and losses are reported — book, market, model, hybrid… but we can’t change the ultimate cash flows from the business, which is what will ultimately drive the value of the firm.  Be careful and conservative here, as accrual entries get more subjective, they become less trustworthy, and managements on average release more into income from accrual entries than they ought to.