FASB Accounting Rules
Did FASB 157 Cause the Financial Crisis?
Since the financial crisis began in February 2007, there has been an ongoing debate in the financial community over the causes of the crisis. One target that has come under fire for its role in the financial meltdown is FASB 157, which created new rules for valuing mortgage-related assets. Wall Street analysts and others blame 157 for implementing mark-to-market accounting standards. They believe that financial institutions took unnecessary losses to accounting rule changes that created billions in paper losses.
This study scrutinizes the role of accounting in general and FASB 157 in particular in creating the crisis. The authors review a number of reports, as well as financial accounting standards 142, 144 and 157. Having reviewed those, the study offers reasons to explain the impact of 157 in the context of other developments in the markets. They also examine how the guidelines apply to the asset categories that were created. The authors discuss fair value methodologies, and highlight problems with level 3 asset valuation. Prior to 157, level 3 assets were valued using a mark-to-model approach that was subject to manipulation and unrealistic assumptions. FASB 157 requires that a fair market value be assigned and that that derivation be disclosed.
The study discusses repercussions to the investment community of exaggerated write-downs and losses to level 3 assets. The authors explain shortcomings in the mark-to-model approach that are mitigated by 157. They highlight ratios of level 3 assets to stockholders' equity for several financial institutions; these ratios demonstrate the magnitude of the problem posed by level 3 assets.
This analysis also presents advantages of FASB 157, discussing the guidelines that bring about greater transparency for investors. Requiring companies to take losses on a yearly basis provides a disincentive for further Wall Street engineering and greed. The authors...
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