Sunday, May 10, 2009

enormous uncertainty in the market because no one knew who was holding what, and who had the bad loans

TO BE NOTED: From Shopyield:

I believe that transparency and neutrality of information actually reduce uncertainty and promote stability.

Excellent speech by John Smith, the Chairman of the International Accounting Standards Board, given May 8th at the European Commission Conference “Financial Reporting in a Changing World”

He begins by making the case for the United States to adopt IFRS (the International Financial Reporting Standards)… this seems an easy decision for a country with a free market economy to make… if we want to attract foreign capital to our markets this is an important form of transparency which allows global investors to make relative comparisons of US and international corporations… one wonders if the Federal Reserve would have had to make such an intense intervention in the commercial paper market if the balance sheets of US issuers were more transparent… from Mr. Smith’s speech…

~~~~ ” …. I will now turn to the financial crisis and our initiatives relating to it. The real estate bubble burst in the United States. Capital deteriorated quickly as banks started reporting huge losses on mortgage loans. That created enormous uncertainty in the market because no one knew who was holding what, and who had the bad loans. So banks stopped lending to each other. They also tightened credit to all customers. Consumers stopped buying. Corporations stopped investing. The stock markets around the world declined. Pension funds lost huge amounts of value, and many jobs were lost.

We had a financial crisis around the world. And banks didn’t have enough capital.

So who and what caused this problem? The fingers started pointing in every direction.

And all of the sudden we increased our accounting vocabulary with a couple of new buzz words—procyclicality and dynamic provisioning—and that old foe, fair value accounting, resurfaced with a new life; and financial reporting and accounting standards became part of the problem

So, how much of the crisis is caused by accounting? I believe very little, if any.

The complaint - current accounting rules promote procyclicality. That part is true but I state it differently. Financial reporting provides information and people react to information. I believe that transparency and neutrality of information actually reduce uncertainty and promote stability.

To be useful to users of financial statements, financial information must be unbiased. That is the role of financial reporting.

That said, I fully recognise that the IASB has an important role to play and there are many lessons learned from the crisis. We have responded by taking an unprecedented number of steps, in a considered fashion, to the crisis. We understand we urgently need to improve many of our standards and we are taking actions to do just that. The IASB approach has been measured, rapid, and targeted at addressing the real issues raised by the crisis.

As to financial reporting, we know there continues to be uncertainty about risk and early on in the crisis we heard calls for more transparency, particularly with regard to risk and off balance sheet activities and about fair value measurement and its use. Those calls were later followed by concerns about financial stability and the calls for greater comparability— a level playing field—and reduced complexity in accounting for financial instruments….

… I would like to talk a little bit about our accelerated financial instruments project.

Our project directly addresses the G20’s call for standard-setters to take action by the year-end ‘to reduce the complexity of accounting standards for financial instruments’.

At a very high level we are all in agreement about the objectives for the project. We need to reduce complexity, increase comparability and transparency, rethink impairment rules to recognise losses more promptly and provide a basis for convergence worldwide, in other words a level playing field.

Our six-month time frame is aggressive, but achievable if we attack the issues in an orderly way and sequentially.

We will start with classification and measurement alternatives. We understand the causes of complexity:

We have 12 different measurement methods for financial instruments including three for impairment.

We have 22+ ways of getting to one of the measurement methods based on a combination of criteria including type of instrument, its activity in the marketplace, management’s intentions by designation, and management’s intentions with various qualifying criteria.

We can reduce complexity if we reduce the measurement alternatives and provide a better rationale for the alternatives that remain. Our goal would be to get to two measurements.

Clearly, some instruments will be at fair value and others will not, but we have to decide how to make the cut.

Is it the characteristics of the instrument, its activity in the marketplace or management’s intentions? Each of these alternatives can complement or conflict with each other, so we have to decide what trumps what, that is to say, what has primacy.

As part of the project, we will address the issue of transfers out of fair value. The consideration here will depend on how we draw the line to distinguish the fair value and non-fair value categories. ” ~~~~

This was written by cate"

No comments: