Fair-Value Accounting: Maintain, Reform, or Eradicate

• Author: S. Taylor Hood
• Position: Student at Capital University Law School, class of 2010
• Pages: 857-887

FAIR-VALUE ACCOUNTING: MAINTAIN, REFORM, OR

ERADICATE

S. TAYLOR HOOD*

I. INTRODUCTION

As of August 2008, financial institu tions around th e world recognized

losses and write-d owns exceeding $501 billion as a result of the U.S.

subprime crisis in 2007 and the ensuing credit cru nch.1 On September 15,

2008, the Dow Jones Indu strial Average experien ced the biggest one-day

decline o n a point basis since the market’s resp onse to the terrorist attacks

of September 11, 20 01.2 A number of factors triggered this drop; most

notably, t he news th at Lehman Brothers w as filing for the biggest

bankruptcy in U.S. hi story, AIG’s an nouncement of restructuring due to a

lack o f liqu idity, and t he federal govern ment’s bailout of Fannie Mae and

Freddie Mac just one week earlier.3 The crisis that was isolated in the

subprime mortgage sector began to affect other fi nancial and nonfinancial

institutions, and the economy as a whole.4 According to the National

Bureau of Economic Research, the U.S. economy began experiencing a

recession in December 2007.5 Some analysts go so far as to compare the

difficult conditions of this economic environment to those of the Great

Copyright © 2010, S. Taylo r Hood.

* Taylor Hood is a student at Capital Univer sity Law School, class of 2010. He

received his B.A . in accounting from Marshall University and is a licensed Certified Public

Accountant in West Virgin ia. Taylor would like to thank the Law Review Editors and

Professor Regina Bur ch for their exceptional advic e and suggestions. He wou ld also like to

thank Whitnie Kropp for he r never-ending, invaluable support and friend ship.

1 Yalman Onaran, Bank s’ Su bprime L osses Top $500 Billion on Writedo wns,

BLOOMBERG, Au g. 12, 2008, h ttp://www.bloomberg.com/apps/news?pid=2060 1087&sid

=a8sW0n1Cs1tY&refer=ho me.

2 Alexandra Tw in, S tocks G et Pu mmeled, CNN MONEY, Sept. 21, 20 08,

http://money.cnn.com/2008 /09/15/markets/markets_newyork2/index .htm.

3 Id.

4 OFFICE OF THE CHIEF AC COUNTANT, SEC, REPORT AND RECOMMENDATIONS PURSUANT

TO SECTION 133 OF THE EMERGENCY ECONOMIC STABILIZATION ACT OF 2008: STUDY ON

MARK-TO-MARKET ACCOUNTING 11 (2008) [hereina fter SEC REPORT], availab le at

http://www.sec.gov/news/s tudies/2008/marktomarket123008.pdf.

5 Id. at 12.

858 CAPITAL UNIV ERSITY LAW REVIEW [38:857

Depression of t he 1930s.6 These conditions sent government officials

scrambling to develop a res cue plan to st abilize the American economy

and fueled a d ebate over wh at factors played a role in creating these

conditions.7

Some of the fact ors cited as po tential causes of t he economic crisis

include: low interest rates, rapid appreciation in the h ousing markets in

previous years, the use of alternativ e mortgage produ cts, and insufficient

regulation.8 One potent ial facto r receiving a considerable amount of

attention is the accounting met hodology known as fair-value ac counting.9

In fact, many financial ins titutions an d other market p articipants allege that

the us e of the fair-value method of acco unting, especially in illiquid

markets, is a prim ary cause of the ongoing financial crisis.10

Congress’s immediate answer to the economic c risis was the passage

of the Emergen cy Economic and Stabili zation Act of 2008 (EESA or th e

Act),11 which President George W. Bush signed into l aw on October 3 ,

2008.12 Congress enact ed the EESA to stabilize t he financial mark ets and

6 Dunstan Prial, Biggest Crisis Since Great Dep ression . . . or Not, FOX BUSINESS, Oct.

2, 2008, http://www.foxb usiness.com/story/biggest-crisis-great-depression-/.

7 See SEC REPORT, supra n ote 4, at 11–12. Congress and President Bush quickly

signed into law the Emergency Economic Stabilization A ct of 2008 o n October 3, 2008, in

response to the economic condition s. See Emergency Economic Stabilization Act of 2008,

Pub. L. No. 110–343 , 122 Stat. 3765 (2008).

8 SEC REPORT, supra note 4, at 11112.

9 Id. The terms “fair-value accounting” and “mark-to-market accounting” are often

used interchangeably. Gary Shorter, F air Value Accoun ting: Context and Current

Concerns, in MARK TO MARKET AND FAIR VAL UE ACCOUNTI NG: AN EXAM INATION 1, 3

(James W. Curti s ed., 2009). However, the term “mark-to-market” i s also used to refer

more spe cifically to the valuing of assets based on current observable market pri ces. See

infra note 34 and accompanying text.

10 Joyce Joseph-Bell et al., Banks: The Fight over Fa ir Value, BUSINESS WEEK, Oct. 15,

2008, http://www.busine ssweek.com/investor/content/oct2008/pi200 81014_361664.htm. In

a speech in Santa Ana, California, 2008 presidential candidate Joh n McCain stated, “[I]t is

time to convene a meeting of the nation’s accounting professiona ls to discuss the current

mark-to-market accounting systems.” Amanda T erkel, McCain Promises a Series of

‘Meetings’ to Solve Hou sing Crisis, THINK PROGRESS, M ar. 25, 2008 , http://thinkprogress.

org/2008/03/25/mccain-hous ing-speech/. He went on to note, “[T ]here is widespread

concern that this approach i s exacerbating the credit crunch.” Id.

11 Emergency Economic Stabili zation Act of 2008, Pub. L. No. 11 0–343, 122 Stat. 3765

(2008).

12See id.