FASB 157: Day of Reckoning?

Does a new fair value standard mean more market pain?  Maybe, maybe not.

Fair value is a term of art accountants use to assign balance-sheet values to assets that companies own.  Asset value to many people is the "historical value" (what you paid for it).   Accountants also mark asset value to the market value; i.e., the price on the open market, mark asset value to a model based on observable inputs; and mark asset value to an in-house model based upon a company's in-house estimates.  These are called, respectively, level One, Two or Three assets.  Level Three assets are typically infrequently traded, illiquid assets.

The Financial Accounting Standards Board, standard-bearer for the accounting industry, announced last year that new fair value standards would be put in place as of November 15.  FASB Statement 157 clarifies that entities will now have to explain how they reach "fair value" prices for Level Three assets.  It doesn't take much analysis to figure out that forcing banks to explain how they valued CDO's and other slices of MBS could lead to announcements of additional losses related to subprime securitization. 

Nouriel Roubini, author of Global EconoMonitor, said in an interview yesterday that forcing companies to consistently explain and value assets instead of marking to a theoretical model means that write downs of 200 - 500 billion dollars are forthcoming and that the probable announcement of such losses means that a recession is a foregone conclusion in the United States. 

A recession might be on the horizon; however, I find it hard to believe that banks and other financial institutions haven't been preparing for FASB 157 since September of 2006.  In fact, the recent spate of write downs are likely a result of 157's arrival.   Of course, I could be wrong.  Wall Street banks and investors have in the past fallen prey to the belief that complex financial models could save them (here and here). 

Also, apparently FASB is deferring 157 for non-financial assets.  Real estate is a non-financial asset; however, that shouldn't matter since part of the theory behind CDO's is that the investor is not investing in real estate. 

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