Oy! Such Enthusiasm!

On November 23rd I wrote,

"I have several very bitter disagreements with the tax thieves. One has to do with their desire to strangle the taxpayer. The term "mark to market" is now getting some attention, but it is an old IRS tactic that was adopted by the people who invent accounting rules. According to the IRS, if the market interest rate is 5%, and I loan you money at 1%, you must pay income tax on the 4% I did not charge you. The accountants were forced by this tactic to come up with a definition of "fair value" that relies on the current market price, even for assets which a taxpayer does not intend to sell. If I buy stock at $1/share on December 30, 2008, and it goes to $2/share on December 31, 2008, and back down to $1/share on January 2, 2009, I have a gain of $1/share for the 2008 tax year, even if it was not realized. For a cash basis taxpayer, there is no effect, but for an accrual basis taxpayer, there is an imaginary taxable gain of 100%. This is the result of "marking the value of the asset at current market price". The tax must be paid in 2009, and you can take a write-off for the imaginary January 2 loss in 2010. IRS will use your money, interest free, in the meantime.

When "mark to market" is applied to assets that are being held for income generating purposes, the decline in the market price of those assets can cause catastrophic effects in the credit ratings of companies. That is why so many lenders and insurance companies are now in a credit crisis. That is why throwing money at the problem will not help. The rules have to change. I advocate that "mark to market" be used only for assets actually traded, and "value in use" be given more emphasis where accrual accounting is utilized. IRS will not be happy with such a concept."

Note that I qualified the conditions for change; that "mark to market" be used only for assets actually traded.

Yesterday (April Fools' Day), bowing to pressure from the banks and the politicians, the Financial Accounting Standards Board (FASB Issues Staff Position 141(R)-1) revised the rules regarding "mark to market". It is a lengthy read. The market has reacted quite positively today to the release of the statement. I have very strong doubts that many of the market participants have read anything beyond the news headlines about the statement.

Of interest to an appraiser is the following :

"8. If the acquisition-date fair value of an asset acquired or a liability assumed in a business combination that arises from a contingency cannot be determined during the measurement period, an asset or a liability shall be recognized at the acquisition date if both of the following criteria are met:

a. Information available before the end of the measurement period indicates that it is probable that an asset existed or that a liability had been incurred at the acquisition date. It is implicit in this condition that it must be probable at the acquisition date that one or more future events confirming the existence of the asset or liability will occur.

b. The amount of the asset or liability can be reasonably estimated.

Criteria (a) and (b) shall be applied using the guidance in Statement 5 and in FASB Interpretation No. 14, Reasonable Estimation of the Amount of a Loss, for application of similar criteria in paragraph 8 of Statement 5."

Remember, an appraiser is one who provides an opinion of market value, while an accountant (or a computer program) provides an estimate of market value. Estimates can be prepared in the complete absence of consideration of the market participants, but opinions must consider what the market participants are actually reacting to.

The following disclaimer was also of interest [my bolds for emphasis]:

"This FSP was adopted by the affirmative votes of four members of the Financial Accounting Standards Board. Mr. Linsmeier dissented.

Mr. Linsmeier dissents from issuance of this FSP because it fails to provide guidance in two key areas, and, therefore, he does not believe the FSP will be operational. First, this FSP requires that an acquirer recognize at fair value an asset acquired or a liability assumed in a business combination that arises from a contingency if the acquisition-date fair value of that asset or liability can be determined during the measurement period without providing guidance as to how to make this assessment. This assessment drives the key differences in the accounting prescribed by this FSP and, if not clear, is likely to raise significant application and comparability issues. Statement 157 provides guidance on how to determine fair value in active and inactive markets and in the presence of both observable inputs and unobservable inputs, which might suggest that fair value should be able to be determined in many, if not most, circumstances. Mr. Linsmeier is concerned that without providing guidance on how to make this determination assessment the Board is being unclear about its intentions, introducing significant judgment in the application of this FSP that will not result in consistent reporting across enterprises.

Second, this FSP does not prescribe in detail how an asset or a liability arising from a contingency initially recognized at fair value in a business combination would be measured subsequent to its initial recognition. This FSP only requires that an acquirer develop a systematic and rational basis for subsequently measuring and accounting for such assets and liabilities depending on their nature, suggesting in the basis for conclusions to this FSP that methods be developed similar to those prescribed in Interpretation 45. While not stated in this FSP, the Board in its deliberations leading to this FSP generally agreed that Statement 5 does not provide appropriate guidance for the subsequent accounting for an asset or a liability arising from a contingency initially recognized at fair value in a business combination. In addition, the majority of the Board did not support subsequent accounting at fair value for those assets and liabilities. The failure to make these tentative decisions authoritative in this FSP and the failure to provide further guidance on the subsequent accounting similar to Interpretation 45 are likely to result in multiple methods for accounting and reporting for identical assets acquired and liabilities assumed in a business combination subsequent to their initial recognition at fair value, causing significant comparability issues for financial statement users across enterprises. As a consequence, Mr. Linsmeier believes this FSP fails to provide sufficient guidance to permit financial statement issuers and their auditors to consistently apply the guidance in this FSP and, as a result, financial statement users will not be provided useful and comparable information about the financial statement effects of assets acquired and liabilities assumed in a business combination that arise from contingencies. "

The Appendix to the statement includes the following items:

"B28. The Board acknowledges that this FSP does not provide investors, creditors, and other users of financial statements with some information that would have been provided had Statement 141(R) not been amended. However, because this FSP will continue to require that an acquirer disclose the amount of the asset or liability recognized at the acquisition date and the nature of the contingency, investors, creditors, and other users of financial statements will receive more information than they received under Statement 141. The Board believes the changes to Statement 141(R) made by this FSP were necessary to address operational issues raised by various constituents that could have resulted in significant costs to preparers.

B32. Differences also exist between the disclosures required by Statement 141(R), as amended by this FSP, and revised IFRS 3. For an asset or liability arising from a contingency recognized at the acquisition date, this FSP requires that the acquirer disclose the amount recognized and the nature of the contingency. For contingencies that are not recognized at the acquisition date, this FSP requires that the acquirer include the disclosures required by Statement 5 in the footnote that describes the business combination. For contingencies in which there is at least a reasonable possibility that a loss will be incurred, Statement 5 requires that an entity disclose the nature of the contingency and give an estimate of the possible loss or range of loss or state that such an estimate cannot be made. Revised IFRS 3 carries forward the existing disclosure requirements in IAS 37 and requires an acquirer to disclose the reasons that the fair value of a contingent liability cannot be measured reliably, if applicable. For recognized contingencies, the acquirer is required to disclose (a) a brief description of the nature of the obligation and the expected timing of any resulting outflows of economic benefits, (b) an indication of the uncertainties about the amount or timing of those outflows, including major assumptions made about future events, where necessary, to provide adequate information, and (c) the amount of any expected reimbursement and the amount of any asset that has been recognized for that expected reimbursement. For unrecognized contingencies, unless the possibility of any outflow in settlement is remote, the acquirer is required to disclose the nature of the contingency and, where practicable, (1) an estimate of its financial effect, (2) an indication of the uncertainties relating to the amount or timing of any outflow, and (3) the possibility of any reimbursement. Under IAS 37, entities also are required to disclose changes in the carrying amount of a contingent liability, including the reasons for those changes. "

The market rally today was said to be a result of investors hoping to see financial stocks show improved profit conditions as a result of application of this rule. While this rule will help in situations where assets held for income production are being analyzed, I would have to agree with Mr. Linsmeier that there is insufficient guidance with respect to supplying investors with information where assets which have defaulted or are in danger of default are being valued. In particular, the downward price pressure on the housing market has, I believe, been understated because the statistics being analyzed have not been adequately filtered to reflect market value as perceived by buyers.

Once the idea sinks in that this is not a cure for the mortgage portfolio devaluation problem, we may see some "morning after" regrets. Choking on furballs is always a danger when one partakes of the hair of the dog which bit him.