Report and Recommendations Pursuant to 

Section 133 of the Emergency Economic Stabilization 

Act of 2008: Study on Mark-To-Market Accounting 

OFFICE OF THE CHIEF ACCOUNTANT 

DIVISION OF CORPORATION FINANCE 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION 

This is a report by the Staff of the U.S. Securities and Exchange Commission. The 

Commission has expressed no view regarding the analysis, findings, or conclusions 

contained herein. 

i

TABLE OF CONTENTS

Commonly-Used Abbreviations viii 

 

Executive Summary 1 

I. Introduction 11 

A. How this Study Fulfills the Statutory Mandate 11 

 1. Statutory Mandate 11 

 2. Context for this Study 11 

 3. Approach to this Study 12 

 4. Structure of this Study 14 

B. The Financial Reporting Framework 15 

 1. Balance Sheet 16 

 2. Income Statement 17 

 3. Other Basic Financial Statements 18 

4. Notes to the Financial Statements, Management’s Discussion and 

Analysis of Financial Condition and Results of Operations, and Other 

Disclosures 19 

C. Other Considerations 20 

1. Role of Accounting in Prudential Oversight 20 

2. International Considerations 20 

 

D. Background Information on Fair Value Accounting 22 

1. Definition of Fair Value 22 

 a. U.S. GAAP 22 

 b. IFRS 23 

2. Application of Fair Value Accounting 24 

 a. How Fair Value Impacts Accounting for Financial Instruments 25 

 i. U.S. GAAP 25 

 ii. IFRS 31 

b. How Fair Value Impacts Accounting for Non-Financial 

Instruments 32 

i. U.S. GAAP 32 

ii. IFRS 33 

 

3. Historical Context for Fair Value Accounting 34 

4. Other Measurement Bases 38 

a. Description of Other Measurement Bases 38 

b. Consideration of Measurement Attributes 40 

 
ii

II. Effects of Fair Value Accounting Standards on Financial Institutions’ Balance Sheets 43 

 A. Methodology for Studying Effects of Fair Value Accounting Standards 43 

B. Empirical Findings from this Study on Effects of Fair Value Accounting 

Standards 45 

 1. Assets 46 

 a. Significance of Assets Measured at Fair Value 46 

 i. Percentage of Assets Measured at Fair Value 46 

ii. Percentage of Assets Measured at Fair Value through 

Income 49 

iii. Distribution of Issuers by Percentage of Assets 

Measured at Fair Value 52 

iv. Use of Fair Value Option 54 

v. Comparison of Percentage of Assets Measured at Fair 

Value Before and After Adoption of SFAS No. 157 and 

SFAS No. 159 57 

b. Nature of Assets Measured at Fair Value on a Recurring Basis 58 

c. Classification of Assets in Fair Value Hierarchy 60 

i. Fair Value Hierarchy Classification over Time 61 

ii. Distribution of Issuers by Percentage of Assets 

Classified as Level 3 63 

2. Liabilities 65 

 a. Significance of Liabilities Measured at Fair Value 65 

 i. Percentage of Liabilities Measured at Fair Value 65 

ii. Distribution of Issuers by Percentage of Liabilities 

Measured at Fair Value 68 

iii. Use of Fair Value Option 70 

iv. Comparison of Percentage of Liabilities Measured at 

Fair Value Before and After Adoption of SFAS No. 

157 and SFAS No. 159 72 

 b. Nature of Liabilities Measured at Fair Value on a Recurring 

Basis 74 

 c. Classification of Liabilities in Fair Value Hierarchy 75 

i. Fair Value Hierarchy Classification over Time 75 

ii. Distribution of Issuers by Percentage of Liabilities 

Classified as Level 3 78 

3. Equity 79 

a. SFAS No. 157 Adoption 79 

b. SFAS No. 159 Adoption 82 

c. Accumulated Other Comprehensive Income 84 
iii

4. Income Statement 86 

a. Recurring Fair Value Measurements 87 

i. Recurring Mark-to-Market Adjustments 87 

ii. Level 3 Fair Value Measurements 89 

iii. Impact of Changes in Creditworthiness in Measuring 

Liabilities 91 

b. Non-Recurring Fair Value Measurements (Impairments) 92 

i. All Impairments 92 

ii. Other-than-Temporary Impairments on Securities 93 

iii. Goodwill Impairment 94 

c. Key Income Statement Drivers Unrelated to Fair Value 

Measurements 94 

d. Conclusions 95 

III. Impact of Fair Value Accounting on Bank Failures in 2008 97 

A. Methodology for Studying Bank Failures 97 

B. Regulatory Framework Governing Bank Failures 99 

1. Capital Adequacy Guidelines 99 

2. Reported Capital Status for 2008 Failed Banks 101 

C. How Fair Value Accounting Affects Reporting under U.S. GAAP for Banks 104 

1. Aggregate Failed Banks < $1 Billion of Total Assets 105 

2. Aggregate Failed Banks > $1 Billion, but < $10 Billion of Total 

Assets 107 

3. Failed Banks > $10 Billion of Total Assets 109 

a. Washington Mutual 109 

b. IndyMac 111 

c. Downey Savings and Loan 113 

D. Interaction Between Regulatory Capital and U.S. GAAP 114 

E. Analysis of Causes of Declines in Failed Bank Capital 117 

1. Aggregate Failed Banks < $1 Billion of Total Assets 118 

2. Aggregate Failed Banks > $1 Billion, but < $10 Billion of Total 

Assets 119 

3. Failed Banks > $10 Billion of Total Assets 120 

a. Washington Mutual 121 
iv

b. IndyMac 123 

c. Downey Savings and Loan 125 

F. Evaluation of the Circumstances Surrounding Each Bank Failure 125 

1. Failed Banks < $1 Billion of Total Assets 126 

2. Failed Banks > $1 Billion, but < $10 Billion of Total Assets 128 

3. Failed Banks > $10 Billion of Total Assets 130 

a. Washington Mutual 133 

b. IndyMac 134 

c. Downey Savings and Loan 135 

G. Impact of Fair Value Accounting on Other Distressed Financial Institutions 136 

IV. Impact of Fair Value Accounting on the Quality of Financial Information Available 

to Investors 139 

A. Investor and User Views About the Use of Fair Value Measurements 139 

1. Comment Letters and Other Public Statements 139 

 a. Representative Survey of Comment Letters 140 

 b. Other Public Statements 143 

 c. Observations 144 

2. Common Themes in Individual Analyst Reports on Fair Value 

Measurements 145 

B. Views Presented by Participants at Recent SEC Fair Value Roundtables 146 

 1. July 9 Roundtable 146 

a. Usefulness of Fair Value and Related Disclosures in Current 

Market Conditions 146 

b. Application of Fair Value Accounting 147 

c. Market Behavior Effects of Fair Value Accounting 147 

d. Impact of Non-Performance Risk on Fair Value of Liabilities 148 

2. October 29 Roundtable 148 

 a. Usefulness of Fair Value Accounting 148 

 b. Market Behavior Effects of Fair Value Accounting 149 

 c. Application of Fair Value Accounting 149 

 d. Interaction with Regulatory Capital Requirements 149 

 e. Potential Changes to Financial Statement Presentation 150 

 3. November 21 Roundtable 150 

 a. Usefulness of Fair Value Information 150 

 b. Asset Impairment Guidance and Estimates of Fair Value 150 

 c. Financial Statement Presentation 151 

 d. Additional Disclosures 151 
v

C. Recent Advisory Committee Recommendations Related to Fair Value 

Measurements 151 

D. Prior Published Staff Views on Fair Value Accounting 153 

E. Abstract of Available Academic Studies Addressing the Impact of Fair Value 

Accounting on the Quality of Information Available to Investors 154 

V. Process Used by the FASB in Developing Accounting Standards 157 

 A. Background and Mission 157 

 B. Governance and Structure 158 

 C. Standard-Setting Process 159 

1. How Topics Are Added to the FASB’s Technical Agenda and 

Developed 160 

2. Accessibility of Meetings 162 

3. Public Exposure of Standards 162 

4. Further Deliberation by the FASB 162 

5. Statements of Financial Accounting Standards 163 

6. Additional Due Process 163 

 a. Resource Groups 163 

 b. Other Due Process 163 

7. Statements of Financial Accounting Concepts 164 

8. Other Documents 164 

9. Emerging Issues Task Force 165 

10. Public Record 165 

 D. Recent Activities with Respect to FASB Governance and Process 165 

 E. FASB’s Interaction with the IASB 168 

VI. Alternatives to Fair Value Accounting Standards 169 

A. Impact of a Suspension of SFAS No. 157 169 

B. Recent Proposals Regarding Measurement Attributes 172 
vi

 1. Broader Issues Related to Identifying Appropriate Measurement 

Bases 173 

 a. Past versus Current Values 175 

 b. Measurement Methods Within Past or Current Values 177 

2. Concepts and Themes Underlying Recent Proposals 178 

a. Theme 1 – Modify Fair Value (For Example, Return to Historical 

Cost) 179 

b. Theme 2 – Modify What is Considered to be a Current Value 

Measure 186 

C. Auditing Standards 188 

VII. Advisability and Feasibility of Modifications to Fair Value Accounting Standards 191 

A. Financial Reporting Responses to Global Economic Crisis 192 

1. SEC Division of Corporation Finance “Dear CFO” Letters 192 

2. SEC / FASB Staff Clarifications on Fair Value Measurements 192 

3. IASB Expert Advisory Panel 192 

4. IASB Fair Value Disclosures 193 

5. IASB Amendments to IAS 39 and IFRS 7 193 

6. Other-than-Temporary Impairment 193 

7. Advisory Group on Financial Reporting Issues Arising from Global 

Economic Crisis 194 

8. G-20 Summit on Financial Markets and the World Economy 194 

9. FASB / IASB Roundtables on Global Financial Crisis 195 

10. Proposed FASB Staff Position on Amendments to EITF Issue No. 

99-20 195 

11. Project on Disclosures for Certain Financial Instruments 195 

12. FASB Project on Recoveries of Other-than-Temporary Impairments 

(Reversals) 196 

B. Current Projects 196 

1. Conceptual Framework Project 196 

2. Financial Statement Presentation Project 197 

a. Segregation of Activities 198 

b. Reconciliation of Cash Flow to Comprehensive Income 198 

c. Disaggregation of Assets / Liabilities Measured on Different 

Bases 198 

3. Reducing Complexity in Reporting Financial Instruments 199 

4. Insurance Contracts Project 199 

5. IASB’s Fair Value Measurement Project 200 
vii

C. Recommendations and Related Key Findings 200 

1. Recommendation – SFAS No. 157 Should Be Improved, but Not 

Suspended 200 

2. Recommendation – Existing Fair Value and Mark-to-Market 

Requirements Should Not Be Suspended 201 

3. Recommendation – Additional Measures Should Be Taken to 

Improve the Application of Existing Fair Value Requirements 202 

4. Recommendation – The Accounting for Financial Asset Impairments 

Should be Readdressed 204 

5. Recommendation – Implement Further Guidance to Foster the Use 

of Sound Judgment 205 

6. Recommendation – Accounting Standards Should Continue to Be 

Established to Meet the Needs of Investors 206 

7. Recommendation – Additional Formal Measures to Address the 

Operation of Existing Accounting Standards in Practice Should Be 

Established 206 

8. Recommendation – Address the Need to Simplify the Accounting for 

Investments in Financial Assets 208 

Appendices 211 

A. Summary of Comment Letters Received as Input to this Study 

B. Participants in SEC Roundtables on Fair Value Accounting 

C. Illustration of Revised Financial Statement Presentation to Segregate Amounts by 

Measurement Attributes, as Proposed by CIFiR 

D. FASB and FAF Members (2008) 
viii

Commonly-Used Abbreviations

Act Emergency Economic Stabilization Act of 2008 

AFS Available-for-Sale 

Agency Appropriate Federal Banking Agency 

Boards FASB and IASB 

CIFiR SEC Advisory Committee on Improvements to Financial Reporting 

Commission United States Securities and Exchange Commission 

EESA Emergency Economic Stabilization Act of 2008 

EITF Emerging Issues Task Force 

FASB Financial Accounting Standards Board 

FDIC Federal Deposit Insurance Corporation 

FDICIA Federal Deposit Insurance Corporation Improvement Act of 1991 

Federal Reserve Board of Governors of the Federal Reserve System 

FVO Fair Value Option 

FSP FASB Staff Position 

GAAP Generally Accepted Accounting Principles 

GSE Government Sponsored Enterprise and Similar Entities 

HFI Held-for-Investment 

HFS Held-for-Sale 

HTM Held-to-Maturity 

IAS International Accounting Standard 

IASB International Accounting Standards Board 

IFRS International Financial Reporting Standard(s) 

MD&A Management’s Discussion and Analysis of Financial Condition and Results 

of Operations 

MSR Mortgage Servicing Right 

OCC Office of the Comptroller of the Currency 

OCI Other Comprehensive Income 

OTS Office of Thrift Supervision 

OTTI Other-than-Temporary Impairment 

PCA Prompt Corrective Action 

PCAOB Public Company Accounting Oversight Board 

Sarbanes-Oxley Act The Sarbanes-Oxley Act of 2002 

SEC United States Securities and Exchange Commission 

SFAC Statement of Financial Accounting Concepts 

SFAS Statement of Financial Accounting Standards 

SOP Statement of Position 

Staff Staff of the United States Securities and Exchange Commission 

TFR Thrift Financial Report 

Treasury Committee The Department of the Treasury’s Advisory Committee on the Auditing 

Profession 
1

Executive Summary 

On October 3, 2008, the Emergency Economic Stabilization Act of 2008 (“EESA” or the “Act”) 

was signed into law.1

 Section 133 of the Act mandates that the U.S. Securities and Exchange 

Commission (the “SEC” or “Commission”) conduct, in consultation with the Board of 

Governors of the Federal Reserve System (“Federal Reserve”) and the Secretary of the Treasury, 

a study on mark-to-market accounting standards as provided by Financial Accounting Standards 

Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value 

Measurements (“SFAS No. 157”).2

As discussed further in this study, SFAS No. 157 does not itself require mark-to-market or fair 

value accounting. Rather, other accounting standards in various ways require what is more 

broadly known as “fair value” accounting, of which mark-to-market accounting is a subset. 

SFAS No. 157 defines fair value, establishes a framework for measuring fair value in U.S. 

generally accepted accounting principles (“GAAP”), and requires expanded disclosures about 

fair value measurements. However, to ensure that this study was responsive to the policy debate 

discussed below, for purposes of this study the SEC Staff (the “Staff”) considered the issue of 

fair value accounting in this larger context, including both mark-to-market accounting and SFAS 

No. 157. 

The events leading up to the Congressional call for this study illustrated the need for identifying 

and understanding the linkages that exist between fair value accounting standards and the 

usefulness of information provided by financial institutions. In the months preceding passage of 

the Act, some asserted that fair value accounting, along with the accompanying guidance on 

measuring fair value under SFAS No. 157, contributed to instability in our financial markets. 

According to these critics, fair value accounting did so by requiring what some believed were 

potentially inappropriate write-downs in the value of investments held by financial institutions, 

most notably due to concerns that such write-downs were the result of inactive, illiquid, or 

irrational markets that resulted in values that did not reflect the underlying economics of the 

securities. These voices pointed out the correlation between U.S. GAAP reporting and the 

regulatory capital requirements of financial institutions, highlighting that this correlation could 

lead to the failure of long-standing financial institutions if sufficient additional capital is 

unavailable to offset investment write-downs. Further, they believed the need to raise additional 

capital, the effect of failures, and the reporting of large write-downs would have broader negative 

impact on markets and prices, leading to further write-downs and financial instability. 

Just as vocal were other market participants, particularly investors, who stated that fair value 

accounting serves to enhance the transparency of financial information provided to the public. 

These participants indicated that fair value information is vital in times of stress, and a 

suspension of this information would weaken investor confidence and result in further instability 

in the markets. These participants pointed to what they believe are the root causes of the crisis, 

namely poor lending decisions and inadequate risk management, combined with shortcomings in 

the current approach to supervision and regulation, rather than accounting. Suspending the use 

 

1

 Pub. L. No. 110-343, Division A. 

2

 See Section 133(a) of the Act. 
2

of fair value accounting, these participants warned, would be akin to “shooting the messenger” 

and hiding from capital providers the true economic condition of a financial institution. These 

participants noted that they were aware of the arguments about the correlation between U.S. 

GAAP reporting and the regulatory capital requirements of financial institutions. However, they 

pointed out that adjustments to the calculation of regulatory capital, like those adjustments 

currently in place for “available-for-sale” (“AFS”) securities, can be made to reduce this 

correlation where appropriate.3

 

As the debate intensified in late September of 2008, SEC Staff and the FASB staff issued a joint 

press release clarifying the application of SFAS No. 157.4

 This joint release clarified the 

measurement of fair value when an active market for a security does not exist. On October 10, 

2008, the FASB issued FASB Staff Position (“FSP”) 157-3, Determining the Fair Value of a 

Financial Asset When the Market for That Asset Is Not Active (“FSP FAS 157-3”), which further 

clarified the application of fair value measurements. 

Currently, the debate over fair value measurements extends beyond national borders and is being 

considered internationally by the International Accounting Standards Board (the “IASB”), the 

standard-setting body for international financial reporting standards (“IFRS”), and other global 

market participants. To coordinate international efforts, and address issues such as fair value 

measurements that have arisen from the global economic crisis, the IASB and FASB (the 

“Boards”) created a global advisory group comprising regulators, preparers, auditors, and 

investors.

As a result of both domestic and international concern, it has become clear that a careful and 

thoughtful consideration of all competing viewpoints is necessary to determine what further 

action may be appropriate. The credibility and experience of parties on both sides of this debate 

demand careful attention to their points and counterpoints on the effects of fair value accounting 

on financial markets. Moreover, a broader understanding of the prevalence of fair value 

accounting relative to other measures of fair value that do not immediately impact a financial 

institution’s income or capital requirements is needed to narrow the issues to those most relevant 

to the debate. 

For many years, accounting standards have required measurement of financial instruments on a 

financial institution’s balance sheet at fair value. In some cases, for example when securities are 

actively traded, changes in fair value are required to be recognized in the income statement. This 

is the specific meaning of “mark-to-market” accounting. However, in most other cases, such 

changes in fair value are generally reported in other comprehensive income (“OCI”) or equity, 

and these changes do not flow through to income unless an impairment has occurred. 

 

3

 AFS securities are measured at fair value on a financial institution’s balance sheet with changes in fair value 

generally reported in a balance sheet line called accumulated other comprehensive income, or equity. The Staff 

understands that changes in fair value reported in other comprehensive income or equity are generally excluded 

from regulatory capital ratios. On the other hand, consistent with safety and soundness objectives, losses on assets 

that are reflected in income and retained earnings in accordance with U.S. GAAP are generally recognized in 

regulatory capital. 

4

 See “SEC Office of the Chief Accountant and FASB Staff Clarifications on Fair Value Accounting,” SEC Press 

Release No. 2008-234 (September 30, 2008). 
3

It is also important, as noted above, to clearly demarcate the difference between the accounting 

standards that require measurement of financial instruments at fair value and SFAS No. 157, 

which only provides guidance on how to estimate fair value. This demarcation is important 

when considering the focus of this study as well as its recommendations. 

Although not mandated for study by the Act, the Staff believes that it is important to recognize 

what many believe to be the larger problem in the financial crisis that led to the financial distress 

at financial institutions other than banks, including The Bear Stearns Companies, Inc. (“Bear 

Stearns”), Lehman Brothers Holdings Inc. (“Lehman”), and Merrill Lynch & Co., Inc. (“Merrill 

Lynch”). Rather than a crisis precipitated by fair value accounting, the crisis was a “run on the 

bank” at certain institutions, manifesting itself in counterparties reducing or eliminating the 

various credit and other risk exposures they had to each firm. This was, in part, the result of the 

massive de-leveraging of balance sheets by market participants and reduced appetite for risk as 

margin calls increased, putting enormous pressure on asset prices and creating a “self-reinforcing 

downward spiral of higher haircuts, forced sales, lower prices, higher volatility, and still lower 

prices.”5

 The trust and confidence that counterparties require in one another in order to lend, 

trade, or engage in similar risk-based transactions evaporated to varying degrees for each firm 

very quickly. What would have been more than sufficient in previous stressful periods was 

insufficient in more extreme times. 

A. The Organization of this Study 

As mandated by the Act, this study addresses six key issues in separate sections. Issues were 

studied using a combination of techniques, which are described in each of the respective 

sections. Where practicable under the time constraints of this study, data was analyzed 

empirically and obtained from a broad-based population that included a cross-section of financial 

institutions. 

For issues that did not lend themselves to empirical analysis, alternative methods were 

undertaken, including Staff research of public records, analysis of public comment letters 

received regarding this study, and the hosting of three public roundtables to obtain a wide range 

of views and perspectives from all parties. Careful attention was given to maximize the 

opportunities for both proponents and opponents of fair value measurements to be heard. 

This study is organized into seven sections, beginning with an introductory section that outlines 

in greater detail the mandate for this study under the Act and background information intended to 

provide readers with a common base of knowledge. Each of the remaining six sections addresses 

one of the issues mandated for study. The following highlights each of these six sections. 

 

5

 Testimony of Timothy F. Geithner, President and Chief Executive Officer, Federal Reserve Bank of New York, 

before the Committee on Banking, Housing and Urban Affairs of the United States Senate on Actions by the Federal 

Reserve Bank of New York in Response to Liquidity Pressures in Financial Markets (April 3, 2008). 
4

1. Effects of Fair Value Accounting Standards on Financial Institutions’ 

Balance Sheets 

This section explores the effects of fair value accounting standards on financial institutions’ 

balance sheets. In the debate concerning fair value accounting, some assert that accounting 

standards that require fair value accounting may inappropriately affect the balance sheets of 

financial institutions. This section studies those concerns by analyzing a sample of fifty financial 

institutions that were selected from a broad-based population of financial institutions in our 

markets. 

The effects of fair value accounting standards on each financial institution was studied to gauge 

the prevalence of assets measured at fair value on the balance sheet and the subset of those assets 

that are also marked-to-market through the income statement. This study also evaluated, among 

other items, the level within SFAS No. 157’s fair value hierarchy in which assets fell.6

 

Information was analyzed by type of financial institution to draw out common characteristics and 

dissimilarities that may exist within each industry type. 

From the sample of financial institutions studied in this section of the study, the Staff observed 

that fair value measurements were used to measure a minority of the assets (45%) and liabilities 

(15%) included in financial institutions’ balance sheets. The percentage of assets for which 

changes in fair value affected income was significantly less (25%), reflecting the mark-to-market 

requirements for trading and derivative investments. However, for those same financial 

institutions, the Staff observed that fair value measurements did significantly affect financial 

institutions’ reported income. 

 

2. Impact of Fair Value Accounting on Bank Failures in 2008 

This section analyzes possible linkages between fair value accounting and bank failures 

occurring during 2008. Some have asserted that fair value accounting contributed to the failure 

of one, or more, financial institutions during 2008. 

For purposes of studying this issue, banks were grouped based on asset size. Within each group, 

this study evaluated banks’ use of fair value measurements over time by analyzing data over a 

period of three years. The Staff also analyzed the key drivers of regulatory capital to evaluate 

the impact of fair value measurements on capital adequacy relative to other factors, such as 

incurred losses on loans. 

The Staff observes that fair value accounting did not appear to play a meaningful role in bank 

failures occurring during 2008. Rather, bank failures in the U.S. appeared to be the result of 

growing probable credit losses, concerns about asset quality, and, in certain cases, eroding lender 

and investor confidence. For the failed banks that did recognize sizable fair value losses, it does 

not appear that the reporting of these losses was the reason the bank failed. 

 

6

 SFAS No. 157’s fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into 

three broad levels. The fair value hierarchy gives the highest priority to unadjusted quoted prices in active markets 

(Level 1) and the lowest priority to unobservable inputs (Level 3). 
5

3. Impact of Fair Value Accounting on the Quality of Financial 

Information Available to Investors 

This section describes investors’ views related to the usefulness of fair value accounting. 

Proponents of fair value accounting assert the importance of such concepts to the transparency of 

financial information provided to investors. To evaluate those assertions, the Staff considered 

how fair value accounting and fair value measurements are used by investors. 

The Staff considered a broad spectrum of investor perspectives, including those focused on both 

debt and equity analysis. The sources of information included Staff research of published 

investor views, analysis of comment letters received by the Commission on this topic, and 

consideration of the views expressed during a series of three roundtables hosted by the 

Commission. In addition, the Staff surveyed academic research on the topic and the conclusions 

of two recent federal advisory committees that addressed fair value accounting as part of their 

respective mandates. 

The Staff’s research on this issue reflects that, based on these sources, investors generally 

support measurements at fair value as providing the most transparent financial reporting of an 

investment, thereby facilitating better investment decision-making and more efficient capital 

allocation amongst firms. While investors generally expressed support for existing fair value 

requirements, many also indicated the need for improvements to the application of existing 

standards. Improvements to the impairment requirements, application in practice of SFAS No. 

157 (particularly in times of financial stress), fair value measurement of liabilities, and 

improvements to the related presentation and disclosure requirements of fair value measures 

were cited as areas warranting improvement. 

4. Process Used by the FASB in Developing Accounting Standards 

This section outlines the independent accounting standard-setting process in the U.S. A key 

aspect of this study mandates consideration of the viability and feasibility of modifications to 

accounting standards that require fair value accounting. To properly understand the viability and 

feasibility of such modifications, a complete understanding of how accounting standards are 

developed and promulgated is important. 

The Staff’s analysis of the FASB’s processes used to develop accounting standards reaffirms that 

an independent accounting standard-setter is best positioned to develop neutral and unbiased 

accounting guidance. The Staff believes that while the FASB’s process works well for this 

purpose, there are several steps that could be taken to enhance the existing procedures. These 

recommendations include steps that could enhance the timeliness and transparency of the 

process. For example, to be responsive to the need to timely identify and address challenges 

encountered in the application of standards in practice, key participants in the capital markets 

need to communicate and understand these challenges as they arise. To facilitate the more 

timely identification and resolution of issues, the Staff believes that it is advisable to move 

quickly to implement the recommendation of the SEC Advisory Committee on Improvements to 

Financial Reporting (“CIFiR”) related to the creation of a financial reporting forum (“FRF”). 
6

5. Alternatives to Fair Value Accounting Standards 

This section examines the potential alternatives to fair value measurements. During the recent 

debate leading to the mandate for this study, some have considered the feasibility of suspending 

SFAS No. 157. This section first addresses the specific consequences of suspending the 

guidance in SFAS No. 157, which would not itself change fair value accounting requirements, 

but rather remove the currently operative guidance for implementation. This section also 

discusses whether it would be prudent to modify the guidance on fair value measurements that 

currently exists. 

This section also examines consideration of a suspension of fair value accounting itself, 

including the positives and negatives of available alternatives, such as historical cost-based 

measures. Valuable insights and thoughts for this section were obtained through review of 

academic research, comment letters received on this study, and also from the perspectives of 

participants at the three public roundtables hosted by the Commission. 

Through its study of this issue, the Staff found that suspending SFAS No. 157 itself would only 

lead to a reversion of practice, resulting in inconsistent and sometimes conflicting guidance on 

fair value measurements. As to alternatives to fair value accounting, while such alternative 

measurement bases exist, each alternative exhibits strengths and weaknesses, as well as 

implementation issues. Considering evidence regarding the usefulness of fair value information 

to investors, the suspension of fair value accounting to return to historical cost-based measures 

would likely increase investor uncertainty. However, given the significant challenges 

encountered in practice related to implementing existing standards, additional actions to improve 

the application and understanding of fair value requirements are advisable. Such additional 

measures to improve the application should include addressing the need for additional guidance 

for determining fair value in inactive markets (including examining the impact of illiquidity), 

assessing whether the incorporation of credit risk in fair value measurement of liabilities 

provides useful information to investors, and enhancing existing presentation and disclosure 

requirements. 

One of the most significant concerns expressed regarding existing fair value standards is the 

current state of accounting for impairments. Currently there are multiple different models 

applied in practice for determining when to record an impairment for investments in securities. 

Additionally, existing impairment guidelines for securities are not consistent with the reporting 

guidelines for impairment charges for other non-securitized investments (e.g., direct investments 

in loans). Accordingly, investors are provided information that is not recognized, calculated, or 

reported on a comparable basis. Further, under existing presentation requirements, investors are 

often not provided sufficient information to fully assess whether declines in value are related to 

changes in liquidity or whether declines relate to probable credit losses. In addition, subsequent 

increases in value generally are not reflected in income until the security is sold. The Staff 

believes that the existing impairment standards should be readdressed with the goal of improving 

the utility of information available to investors. 
7

6. Advisability and Feasibility of Modifications to Fair Value 

Accounting Standards 

This final section summarizes steps taken and underway to improve upon current accounting 

requirements. This section also provides recommendations on the advisability and feasibility of 

modifications to existing accounting standards and related financial reporting requirements, 

which are discussed below. 

B. Recommendations 

The recommendations, and the observations leading to the related recommendations, are 

described in detail in the final section of this study. For ease of reference, the following table 

provides an executive summary of the recommendations based upon the observations of this 

study. To facilitate an understanding for how each recommendation was developed, each 

recommendation below is associated with relevant observations that indicated a need for action 

or improvement. 

Recommendation #1

SFAS No. 157 should be 

improved, but not suspended. 

Observations

• The guidance in SFAS No. 157 does not 

determine when fair value should be applied. 

SFAS No. 157 only provides a common 

definition of fair value and a common 

framework for its application. 

• Suspending SFAS No. 157 itself would only 

revert practice to inconsistent and sometimes 

conflicting guidance on fair value 

measurements. 

• Other recommendations address necessary 

improvements to existing standards. 

Recommendation #2

Existing fair value and mark-tomarket requirements should not 

be suspended. 

Observations

• Fair value and mark-to-market accounting has 

been in place for years and abruptly removing it 

would erode investor confidence in financial 

statements.

• Fair value and mark-to-market accounting do 

not appear to be the “cause” of bank and other 

financial institution failures.

• Mark-to-market accounting is generally limited 

to investments held for trading purposes and for 

certain derivative instruments; for many 

financial institutions, these represent a minority 

of their total investment portfolio.
8

• Over 90% of investments marked-to-market are 

valued based on observable inputs, such as 

market quotes obtained from active markets.

• Investors generally agree that fair value 

accounting provides meaningful and transparent 

financial information, though improvements are 

desirable.

Recommendation #3

While the Staff does not 

recommend a suspension of 

existing fair value standards, 

additional measures should be 

taken to improve the application 

and practice related to existing 

fair value requirements 

(particularly as they relate to 

both Level 2 and Level 3 

estimates). 

Observations

• Fair value requirements should be improved 

through development of application and best 

practices guidance for determining fair value in 

illiquid or inactive markets. This includes 

consideration of additional guidance regarding: 

o How to determine when markets become 

inactive 

o How to determine if a transaction or group of 

transactions is forced or distressed 

o How and when illiquidity should be 

considered in the valuation of an asset or 

liability, including whether additional 

disclosure is warranted 

o How the impact of a change in credit risk on 

the value of an asset or liability should be 

estimated 

o When observable market information should 

be supplemented with and / or reliance 

placed on unobservable information in the 

form of management estimates 

o How to confirm that assumptions utilized are 

those that would be used by market 

participants and not just by a specific entity 

• Existing disclosure and presentation 

requirements related to the effect of fair value in 

the financial statements should be enhanced. 

• FASB should assess whether the incorporation 

of changes in credit risk in the measurement of 

liabilities provides useful information to 

investors, including whether sufficient 

transparency is provided. 

• Educational efforts to reinforce the need for 

management judgment in the determination of 

fair value estimates are needed. 

• FASB should consider implementing changes to 

its Valuation Resource Group. 
9

Recommendation #4

The accounting for financial 

asset impairments should be 

readdressed. 

Observations

• U.S. GAAP does not provide a uniform model 

for assessing impairments. 

• The prominence of the measure “OCI,” where 

certain impairments are disclosed, could be 

enhanced by requiring its display on the income 

statement.

• For many financial institutions, financial assets 

marked-to-market through the income statement 

represent a minority of their investment 

portfolio.

• A large portion of financial institutions’ 

investment portfolios consist of AFS securities 

or loans, subject to challenging judgments 

related to impairment, which determines when 

such losses are reported in the income statement.

• Current impairment standards generally preclude 

income recognition when securities prices 

recover until investments are sold.

Recommendation #5

Implement further guidance to 

foster the use of sound judgment. 

Observations

• SFAS No. 157 is an objectives-based accounting 

standard that relies on sound, reasoned judgment 

in its application.

• Sound judgment is a platform from which to 

foster the neutral and unbiased measures of fair 

value desired by investors.

• Requests have been made for the Commission 

and the Public Company Accounting Oversight 

Board (“PCAOB”) to emphasize their support 

for sound judgment in the application of 

accounting and auditing standards.

Recommendation #6

Accounting standards should 

continue to be established to 

meet the needs of investors. 

Observations

• Investors, and most others, agree that financial 

reporting’s primary purpose is to meet the 

information needs of investors. 

• Most appear to agree that fair value 

measurements provide useful information to 

investors, meeting their information needs. 

• Beyond meeting the information needs of 

investors, general-purpose financial reporting 

has secondary uses that may be of additional 
10

utility to others, such as for prudential oversight. 

• General-purpose financial reporting should not 

be revised to meet the needs of other parties if 

doing so would compromise the needs of 

investors. 

Recommendation #7

Additional formal measures to 

address the operation of existing 

accounting standards in practice 

should be established. 

Observations

• While the existing FASB process works well, 

steps could be taken to enhance the process. 

• After adoption of new accounting standards, 

unforeseen implementation issues often may 

arise. 

• An independent accounting standard-setter is 

best equipped to address broadly effective 

implementation issues that arise from the 

adoption of a new accounting standard. 

• Independent accounting standard-setters are well 

served by the input received from a broad 

spectrum of constituents.

• Critical to the success of an independent 

accounting standard-setter is its timely 

responsiveness to the information needs of 

investors. 

Recommendation #8

Address the need to simplify the 

accounting for investments in 

financial assets. 

Observations

• The prominence of OCI could be enhanced by 

requiring its display on the income statement.

• Many investors feel that clear disclosure of the 

inputs and judgments made when preparing a 

fair value measurement is useful. 

• While a move to require fair value measurement 

for all financial instruments would likely reduce 

the operational complexity of U.S. GAAP, the 

use of fair value measurements should not be 

significantly expanded until obstacles related to 

such reporting are further addressed. 
11

I. Introduction 

A. How this Study Fulfills the Statutory Mandate 

1. Statutory Mandate 

The mandate for this study comes from the Emergency Economic Stabilization Act of 2008, 

which was signed into law on October 3, 2008. Section 133 of the Act mandates that the SEC 

conduct, in consultation with the Federal Reserve and the Secretary of the Treasury, 

a study on mark-to-market accounting standards as provided in Statement Number 157 of 

the Financial Accounting Standards Board, as such standards are applicable to financial 

institutions, including depository institutions. Such a study shall consider at a 

minimum— 

(1) the effects of such accounting standards on a financial institution’s balance 

sheet; 

(2) the impacts of such accounting on bank failures in 2008; 

(3) the impact of such standards on the quality of financial information available 

to investors; 

(4) the process used by the Financial Accounting Standards Board in developing 

accounting standards; 

(5) the advisability and feasibility of modifications to such standards; and 

(6) alternative accounting standards to those provided in such Statement Number 

157.7

Section 133 of the Act also mandated that the Commission 

shall submit to Congress a report of such study before the end of the 90-day period 

beginning on the date of the enactment of this Act containing the findings and 

determinations of the Commission, including such administrative and legislative 

recommendations as the Commission determines appropriate.8 

2. Context for this Study 

Over the last 12 to 18 months, the world economy has experienced economic conditions that 

have affected financial and non-financial institutions. What at one time some viewed as an 

isolated crisis in the subprime mortgage sector has spread to the global economy as a whole. 

Factors that have been cited as causing or contributing to the current economic crisis include, 

among others, low interest rates, rapid housing appreciation, alternative mortgage products, 

relaxed underwriting standards, increased leverage, innovative new investments that were 

 

7

 Section 133(a) of the Act. 

8

 Section 133(b) of the Act. 
12

believed to be safer than perhaps warranted, and insufficient regulation.9

 While financial 

institutions are experiencing the brunt of increasing mortgage defaults, housing foreclosures, 

bank failures, and tighter credit, other industries are experiencing losses, liquidity issues, rapid 

decreases in market capitalization, layoffs, and lower consumer confidence – all underscored by 

the National Bureau of Economic Research’s recent announcement that the U.S. has been in a 

recession since December 2007, which is expected to “likely be the longest, and possibly one of 

the deepest, since World War II.”10 

While analysis of the causes of this crisis is still underway, some believe that fair value 

accounting standards have contributed to or exacerbated this crisis, arguing that use of fair value 

accounting, particularly when markets are illiquid, has resulted in the valuing of assets well 

below their “true economic value.”11 Opponents of fair value accounting also argue that these 

write-downs have caused a downward spiral, as they have triggered margin and regulatory 

capital calls, “have forced rapid asset liquidation, exacerbating the loss of value, diminished 

counterparty confidence, and constrained liquidity.”12 Proponents counter that fair value 

accounting provides useful information to investors and its suspension would increase market 

uncertainty and decrease transparency.13 It is in this context that the Staff has performed this 

study of mark-to-market accounting to fulfill the Congressional mandate. 

3. Approach to this Study 

In order to fulfill the mandate and produce this study, the Staff has assigned meaning, as 

described below, to the terms “mark-to-market accounting standards,” “financial institutions,” 

and “bank failure.” When used in other contexts, these terms may have different definitions or 

meanings. 

• For the purposes of this study, the Staff interprets “mark-to-market accounting standards” as 

accounting standards under U.S. GAAP that define fair value and / or require or permit fair 

value measurement in the financial statements with changes reported in income. 

Accordingly, “mark-to-market accounting standards” include, but are not limited to, SFAS 

No. 115, Accounting for Certain Investments in Debt and Equity Securities (“SFAS No. 

115”); SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS 

 

9

 See, e.g., The President’s Working Group on Financial Markets, Policy Statement on Financial Market 

Developments (March 2008); Robert Herz, Chairman, FASB, Lessons Learned, Relearned, and Relearned Again 

from the Credit Crisis – Accounting and Beyond (September 18, 2008); and The Financial Stability Forum, Report 

of the Financial Stability Forum on Enhancing Market and Institutional Resilience (April 7, 2008). 

10 “Statement by Chad Stone, Chief Economist, on the November Employment Report,” Center on Budget and 

Policy Priorities (December 5, 2008). 

11 See, e.g., letter from Isaac. Comment letters (“letters”) are available on the Commission’s website (at 

http://www.sec.gov/comments/4-573/4-573.shtml), and in the Commission’s Public Reference Room in its 

Washington, DC headquarters. Unless otherwise noted, comment letters in this study are cited by author (using the 

abbreviations in Exhibit A-1 to the comment summary, which is available at Appendix A to this study) and, if 

multiple letters were submitted by the same author, also by date. 

12 Joyce Joseph-Bell, Ron Joas & Neri Bukspan, Banks: The Fight over Fair Value, BusinessWeek, October 15, 

2008. 

13 See, e.g., letter from Joint (October 15, 2008). 
13

No. 133”); SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and 

Extinguishments of Liabilities (“SFAS No. 140”); SFAS No. 155, Accounting for Certain 

Hybrid Financial Instruments (“SFAS No. 155”); SFAS No. 156, Accounting for Servicing 

of Financial Assets (“SFAS No. 156”); SFAS No. 157; and SFAS No. 159, The Fair Value 

Option for Financial Assets and Financial Liabilities (“SFAS No. 159”). 

• The term “financial institutions” is defined by the EESA to include public and non-public 

banks, insurance companies, and broker-dealers.14 For purposes of Section II, and given the 

time constraints of this study, the Staff has limited the study sample to public companies, due 

to the readily available financial data for these entities. The Staff also included credit 

institutions15 and government-sponsored enterprises and similar entities (“GSEs”),16 as they 

are additional institutions in the financial sector that may be affected by fair value accounting 

standards. 

• For purposes of Section III of this study, a “bank failure” refers to an insured depository 

institution that is closed by the appropriate state or federal chartering authority in accordance 

with applicable law or regulations or by the appropriate federal banking agency (“Agency”) 

based on the authority provided under the Federal Deposit Insurance Act,17 entitled Prompt 

Corrective Action (“PCA”). 

In addition, investment companies are subject to different standards than those of non-investment 

companies.18 Accordingly, the Staff determined those companies to be outside the scope of this 

study and they are generally not contemplated in the remainder of this study. 

The methodologies used by the Staff to gather and analyze data for Sections II - VII of this study 

are described in each of those sections. Broadly, the Staff gathered information for this study 

through: (1) a review of publicly available financial and other information, (2) consultations with 

 

14 Specifically, Section 3(5) of the Act defines “financial institutions” to mean 

...any institution, including, but not limited to, any bank, savings association, credit union, security broker 

or dealer, or insurance company, established and regulated under the laws of the United States or any State, 

territory, or possession of the United States, the District of Columbia, Commonwealth of Puerto Rico, 

Commonwealth of Northern Mariana Islands, Guam, American Samoa, or the United States Virgin Islands, 

and having significant operations in the United States, but excluding any central bank of, or institution 

owned by, a foreign government. 

15 The Staff refers to establishments primarily engaged in providing loans to individuals as “credit institutions.” 

Also included in this industry are establishments primarily engaged in financing retail sales made on the installment 

plan and financing automobile loans for individuals. 

16 “GSEs” refers to GSEs and other non-depository credit intermediation institutions that primarily provide federally 

guaranteed loans. 

17 12 U.S.C. 1811 et seq.

18 Investment companies include entities registered under the Investment Company Act of 1940 [15 U.S.C. 80a-1 et

seq. (the “Investment Company Act”)] and business development companies. Section 2(a)(41) of the Investment 

Company Act defines “value” with respect to the assets of registered investment companies and business 

development companies and generally requires the use of either: (1) market value when market quotations are 

readily available or (2) fair value, as determined in good faith by the Board of Directors, when market quotations are 

not readily available. 
14

the Federal Reserve and the Department of Treasury, as mandated by the Act, as well as other 

federal banking regulators and the FASB, (3) a review of relevant academic research on fair 

value accounting, and (4) a request for public comment19 and a series of three public 

roundtables20 to obtain constituent views about fair value. Views from commenters that 

responded to the Staff’s request for public comment and roundtable participants are referenced 

throughout this study. A summary of comments and commenters is provided in Appendix A to 

this study. A summary of the public roundtable discussions is presented in Section IV and a list 

of roundtable participants is provided in Appendix B to this study. 

4. Structure of this Study 

The remainder of this introductory section contains the following subsections: 

• Subsection B presents a short primer summarizing the financial reporting framework, 

including the basic accounting concepts necessary to understand the issues discussed in this 

study. Those who are familiar with the financial reporting framework may skip this 

subsection of the study with no loss of continuity. 

• Subsection C presents other considerations, namely the role of accounting in prudential 

oversight and international developments, which necessitate consideration throughout this 

study. 

• Subsection D presents background information on fair value accounting, including the 

definition of fair value, information about the application of fair value accounting, a 

historical context for mark-to-market or fair value accounting, and information about other 

measurement bases used in accounting. 

The remainder of this study is generally arranged according to the order of the sections in the 

legislative mandate, with one exception to facilitate organization: the section describing 

“Alternatives to Fair Value Accounting Standards” appears before the section describing 

“Advisability and Feasibility of Modifications to Fair Value Accounting Standards.” 

Specifically: 

• Section II of this study is “Effects of Fair Value Accounting Standards on Financial 

Institutions’ Balance Sheets.” This section examines the balance sheets of a sample of public 

financial institutions to analyze total assets and liabilities that were measured at fair value 

and the extent to which changes in fair value impacted those institutions’ income statements.

• Section III of this study is “Impact of Fair Value Accounting on Bank Failures in 2008.” 

This section examines the extent to which public and non-public failed banks applied fair 

 

19 See SEC Release No. 33-8975 (October 8, 2008), SEC Study of Mark to Market Accounting Request for Public 

Comment. 

20 Commission roundtables took place on July 9, 2008 (International Roundtable on Fair Value Accounting 

Standards), October 29, 2008 (Roundtable on Mark-to-Market Accounting), and November 21, 2008 (Mark-toMarket Accounting Roundtable). (Archived webcasts are available at: http://www.sec.gov/spotlight/fairvalue.htm.) 
15

value accounting and whether fair value accounting contributed significantly to their failures. 

This section also discusses the impact of fair value accounting on other distressed financial 

institutions. 

• Section IV of this study is “Impact of Fair Value Accounting on the Quality of Financial 

Information Available to Investors.” This section discusses the views of investors and other 

financial statement users on the role of fair value accounting and whether it enhances or 

impairs their understanding of financial information. 

• Section V of this study is “Process Used by the FASB in Developing Accounting Standards.” 

This section discusses the FASB governance and processes that result in the accounting 

standards U.S. public companies apply. 

• Section VI of this study is “Alternatives to Fair Value Accounting Standards.” This section 

examines the potential impact of a suspension of SFAS No. 157 and recent proposals 

regarding alternatives to fair value accounting. 

• Section VII of this study is “Advisability and Feasibility of Modifications to Fair Value 

Accounting Standards.” This section outlines current actions taken and projects in process to 

address and improve existing fair value accounting standards. Further, this section draws 

upon the analysis and findings of the previous sections of this study and develops a list of 

recommendations of additional measures to improve fair value accounting and the 

accounting for financial asset impairments. 

B. The Financial Reporting Framework21 

The objective of financial reporting is to provide information useful to investors and creditors in 

their decision-making processes.22 The Commission has responsibilities under the federal 

securities laws to specify acceptable standards for the preparation of financial statements that 

provide this financial information.23 The Commission has, for virtually its entire existence, 

looked to the private sector for assistance in this task. Currently, the body that the Commission 

looks to for the setting of financial reporting standards for U.S. issuers is the FASB.24 The 

FASB has promulgated accounting standards in many areas and has also created a conceptual 

 

21 Parts of this section are excerpted, with modifications, from SEC Staff, Report and Recommendations Pursuant to 

Section 401(c) of the Sarbanes-Oxley Act of 2002 On Arrangements with Off-Balance Sheet Implications, Special 

Purpose Entities, and Transparency of Filings by Issuers, (“Off-Balance Sheet Report”). (This report is available at: 

http://www.sec.gov/news/studies/soxoffbalancerpt.pdf.) 

22 See Statement of Financial Accounting Concept (“SFAC”) No. 1, Objectives of Financial Reporting by Business 

Enterprises (“SFAC No. 1”), paragraph 32. 

23 See, e.g., Sections 7, 19(a) and Schedule A, Items (25) and (26) of the Securities Act of 1933 (the “Securities 

Act”), 15 U.S.C. 77g, 77s(a), 77aa(25) and (26); Sections 3(b), 12(b) and 13(b) of the Securities Exchange Act of 

1934 (the “Exchange Act”), 15 U.S.C. 78c(b), 78l(b) and 78m(b); and Sections 8, 30(e), 31 and 38(a) of the 

Investment Company Act, 15 U.S.C. 80a-8, 80a-29(e), 80a-30 and 80a-37(a). 

24 See SEC Release No. 33-8221 (April 25, 2003), Policy Statement: Reaffirming the Status of the FASB as a 

Designated Private-Sector Standard Setter (“2003 Policy Statement”). 
16

framework for accounting and financial reporting that it uses in setting accounting standards. 

However, despite the Commission’s recognition of the FASB’s financial accounting and 

reporting standards as “generally accepted” for purposes of the federal securities laws, the 

Commission retains the authority to require U.S. issuers to apply accounting other than that set 

by the FASB to ensure compliance with the securities laws and the protection of investors.25 

Filings by issuers include four main financial statements: the balance sheet, the income 

statement, the cash flow statement, and the statement of changes in equity.26 Each financial 

statement provides different types of information, but they are interrelated in that they “reflect 

different aspects of the same transactions or other events affecting an entity,” as well as 

complementary in that “none is likely to serve only a single purpose or provide all the financial 

statement information that is useful for a particular kind of assessment or decision.”27 

A 

complete set of financial statements also includes notes, which disclose quantitative and 

qualitative information not in the basic four financial statements. Public filings also generally 

require the inclusion of additional information, including information about the company’s 

business, the risk factors it faces, and a discussion of its financial condition, results of operations, 

liquidity, and capital resources. 

1. Balance Sheet 

Given the topic of this study, the Staff’s primary focus is on the balance sheet and the income 

statement. The balance sheet portrays an issuer’s financial position at a point in time. Its basic 

components include: 

• Assets, which are “probable future economic benefits obtained or controlled by a particular 

entity as a result of past transactions or events;”28

• Liabilities, which are “probable future sacrifices of economic benefits arising from present 

obligations of a particular entity to transfer assets or provide services to other entities in the 

future as a result of past transactions or events;”29 and 

• Equity, which is “the residual interests in the assets of an entity that remains after deducting 

its liabilities.”30

Under current accounting standards in the U.S., the items that are recorded on the balance sheet 

are valued or measured using different measurement bases or attributes. This use of different 

 

25 See, e.g., Sections 3(c) and 108(c) of the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”), 15 U.S.C. 

7202(c) and 7218(c). 

26 See SFAC No. 5, Recognition and Measurement in Financial Statements of Business Enterprises (“SFAC No. 5”), 

paragraphs 39-41 and 55-57. 

27 SFAC No. 5, paragraph 23; see also paragraph 24. 

28 SFAC No. 6, Elements of Financial Statements (“SFAC No. 6”), paragraph 25. 

29 Ibid., paragraph 35. 

30 Ibid., paragraph 49. 
17

measurement attributes is often referred to as the “mixed-attribute model.” Under the current 

mixed-attribute model, the carrying amounts of some assets and liabilities are reflected in the 

balance sheet at historical cost, some at fair value, and some at other bases, such as lower-ofcost-or-fair-value. Financial accounting standards in the U.S. establish the basis on which items 

reported in the balance sheet should be measured. Section I.D of this study more fully describes 

measurement bases that the FASB considers in setting standards. 

Measurement using historical cost can be done in several ways, but the general concept is to 

record items on the balance sheet using the original amount paid or received, with or without 

adjustments in subsequent periods for depreciation, amortization, or impairment. Accordingly, 

one historical cost measure is not necessarily comparable to another historical cost measure due 

to differences in when the historical cost was measured and the individual amount paid or 

received, as well as differences in depreciation, amortization, and impairment techniques or 

requirements. 

Fair value measurement is defined by SFAS No. 157. Prior to the issuance of SFAS No. 157 in 

2006, “fair value” was defined or described in various accounting standards that prescribe its use, 

but the definition of fair value, and its application, were not necessarily consistent across 

standards.31 SFAS No. 157 now provides a standardized definition of fair value. Section I.D of 

this study further explains the definition of fair value provided in SFAS No. 157. Other 

measurement bases, such as lower-of-cost-or-fair-value, are described or explained in the 

accounting standards in which they are used.32 In connection with a current joint project to 

improve upon their respective conceptual frameworks, the Boards are focusing on measurement 

bases that are appropriate for future standard-setting. Rather than referring to “historical cost” 

versus “fair value,” the Boards are focusing on nine measurement bases that are related to either 

past, present or future prices or amounts. The Boards’ work is discussed further in Sections I.D 

and VI.B of this study. 

2. Income Statement 

The income statement reflects the issuer’s revenues and expenses, gains and losses, and, thus, is 

intended to capture “the extent to which and the ways in which the equity of an entity increased 

or decreased from all sources other than transactions with owners during a period.”33 Over the 

years, there has been tremendous controversy about what should be reported in the income 

statement. In large part, the controversy can be traced to the fact that net income (often 

expressed as a per share measure) often receives more focus than other measures in evaluating 

performance. As such, a decision or proposal to change accounting standards in a way that 

would result in more volatility being reported in income has often prompted controversy. 

 

31 See SFAS No. 157, Reasons for Issuing this Statement. 

32 See, e.g., SFAS No. 65, Accounting for Certain Mortgage Banking Activities (“SFAS No. 65”), paragraphs 9-10. 

33 SFAC No. 5, paragraph 30. There are several transactions that meet the criteria to be included in the income 

statement, but have nonetheless been excluded from net income, and are instead categorized as OCI. 
18

Due to the complementary and integrated nature of the balance sheet and income statement, 

choosing the accounting treatment for one statement has implications for the other.34 One of the 

most critical and timely examples relates to standards that require the recognition of more assets 

and liabilities on the balance sheet at their fair values. For some assets and liabilities that are 

measured at fair value on the balance sheet, unrealized changes (gains and losses) in fair value 

from period to period impact net income, while, for other assets and liabilities that are measured 

at fair value, unrealized changes in fair value do not impact net income, but instead are recorded 

through the equity section of the balance sheet by way of an accounting construct referred to as 

OCI. Unrealized gains and losses related to assets and liabilities are those that occur while an 

issuer holds the asset or liability, as opposed to realized gains and losses that generally occur 

when an asset or liability is sold or settled. 

Proponents of the “all inclusive” approach to defining net income contend that it is appropriate to 

include both realized and unrealized gains and losses in net income because this information 

enables users to better predict future income or cash flows. However, others point out that 

recording unrealized gains and losses in the income statement may lead to increased income 

volatility, which they believe results in lower predictability of future income or cash flows. As 

noted above, the alternative to reporting unrealized gains and losses as part of net income is to 

report these changes in OCI, which most often appears in the statement of changes in equity,35

until the gain or loss is realized generally through sale of the asset or settlement of the liability. 

3. Other Basic Financial Statements 

The other two basic financial statements describe, each in their own way, the changes in various 

balance sheet items from one period to the next. 

The statement of changes in equity reflects the ways in which assets and liabilities have changed 

due to transactions with owners during the period, such as declarations of dividends, issuances of 

stock and options, exchanges of shares in mergers and acquisitions, and items that are classified 

outside of the measurement of net income (i.e., OCI, as discussed above).

 

The cash flow statement reflects an entity’s cash receipts classified by major sources and its cash 

payments classified by major uses during a period. 

This statement groups the inflows and 

outflows of cash into three broad categories: operating cash flows, investing cash flows, and 

financing cash flows. 

Operating cash flows include: cash received from customers; cash spent on materials and labor; 

cash paid for utilities, insurance, compensation and benefits; and many other types of operating 

items. The other two sections of the cash flow statement report investing cash flows and 

financing cash flows. Investing cash flows include: cash inflows and outflows related to 

 

34 Historically, the relative focus of standard-setters on the balance sheet versus the income statement (or vice versa) 

has varied. The balance sheet was emphasized in the early part of the 20th Century (and before), in part because 

creditors had little reliable information available to them. Liquidation values and conservatism were of central 

importance. By the late 1930s, the focus shifted to a shareholder orientation, the income statement and value in use 

rather than liquidation value. See Elden S. Hendriksen, Accounting Theory, 257 (4th ed. 1982). 

35 The statement of changes in equity is discussed further in Section I.B.3. 
19

purchases or sales of property, plant, and equipment; investments in equity or debt of other 

entities; and other types of investments. Financing cash flows include: cash inflows from raising 

capital through issuing stock or debt, cash outflows to repay mortgages and other liabilities, cash 

paid for dividends, and the like. 

4. Notes to the Financial Statements, Management’s Discussion and 

Analysis of Financial Condition and Results of Operations, and Other 

Disclosures 

The basic financial statements alone cannot reasonably be expected to provide sufficient 

information for investment decisions. The FASB’s concept statements note that “[s]ome useful 

information is better provided by financial statements and some is better provided, or can only be 

provided, by notes to financial statements or by supplementary information or other means of 

financial reporting.”36 These disclosures in the notes to the financial statements are intended to 

provide information that the four main financial statements cannot (or do not) provide. 

In addition, although the notes provide much information that is not provided in the basic 

financial statements, they generally do not provide an explanation of the business activities 

underlying the numbers. Recognizing that such information may be as important to investors as 

the information in the financial statements and notes, the Commission requires issuers to include 

a management’s discussion and analysis of financial condition and results of operations 

(“MD&A”) section in many filings. MD&A requires a discussion of known trends, demands, 

commitments, uncertainties, and events that are reasonably likely to materially affect the issuer’s 

financial condition, results of operations, or liquidity, as well as other information that provides 

context to the financial statements. As noted in Financial Reporting Release 67: 

The disclosure in MD&A is of paramount importance in increasing the 

transparency of a company's financial performance and providing investors with 

the disclosure necessary to evaluate a company and to make informed investment 

decisions. MD&A also provides a unique opportunity for management to provide 

investors with an understanding of its view of the financial performance and 

condition of the company, an appreciation of what the financial statements show 

and do not show, as well as important trends and risks that have shaped the past or 

are reasonably likely to shape the future.37 

Because of the importance of the notes to the financial statements and other disclosures, 

including MD&A, in providing information that is not provided by the basic financial statements 

themselves, questions of whether items should or should not be included on the balance sheet 

and income statement and whether sufficient transparency in reporting has been achieved must 

be assessed in light of the presence and role of these other reporting tools. 

 

36 SFAC No. 5, paragraph 7. 

37 SEC Release No. 33-8182 (January 28, 2003), Disclosure in Management's Discussion and Analysis about OffBalance Sheet Arrangements and Aggregate Contractual Obligations. 
20

C. Other Considerations 

1. Role of Accounting in Prudential Oversight 

Financial information is also used in prudential oversight. The primary objective of prudential 

oversight is to foster safety and soundness and financial stability.38 For prudential oversight 

purposes, regulatory capital requirements for banks in the U.S. start with financial information 

provided in accordance with U.S. GAAP. However, in certain instances, the effects of U.S. 

GAAP accounting are adjusted, thereby reflecting the important differences between the 

objectives of U.S. GAAP reporting and the objectives of U.S. bank regulatory capital 

requirements. These adjustments are discussed in greater detail in Section III.D. 

Consistent with the Act’s mandate, the focus of this study is on financial reporting for investors, 

rather than prudential supervisors. However, because of the role of prudential oversight in bank 

failures and the existing relationship between U.S. GAAP and regulatory capital, where relevant, 

this study also discusses such considerations. 

2. International Considerations 

As mandated by the Act, this study principally focuses on fair value accounting in the context of 

U.S. companies reporting under U.S. GAAP. However, developments over the past few years 

necessitate consideration of the international financial reporting landscape. 

First, on a global basis, the number of companies that report under IFRS has increased 

substantially. In 2002, the European Union (“E.U.”) adopted a regulation requiring its listed 

companies to report under IFRS by 2005.39 Since then, other countries have followed suit. 

Approximately 113 countries around the world currently require or permit IFRS reporting for 

domestic, listed companies, including the E.U., Australia, and Israel.40 The market capitalization 

of exchange listed companies in the E.U., Australia, and Israel totals $11 trillion (or 

approximately 26% of global market capitalization), and the market capitalization from those 

countries plus Brazil and Canada, both of which have announced plans to move to IFRS, totals 

$13.4 trillion (or approximately 31% of global market capitalization).41 

Second, the Boards have made concerted efforts to converge U.S. GAAP and IFRS to minimize 

or eliminate differences in the two bodies of accounting literature. This process began with the 

signing of the “Norwalk Agreement” by the Boards in October 2002.42 In this agreement, the 

 

38 See Basel Committee on Banking Supervision, Core Principles for Effective Banking Supervision (October 2006). 

39 See Regulation (EC) No. 1606/2002 of the European Parliament and of the Council of the European Union of 19 

July 2002 on the Application of International Accounting Standards, Official Journal L. 243, November 9, 2002, at 

pages 0001-0004. 

40 See SEC Release No. 33-8982 (November 14, 2008), Roadmap for the Potential Use of Financial Statements 

Prepared in Accordance with International Financial Reporting Standards by U.S. Issuers (“Proposed Roadmap”). 

41 Ibid. 

42 See the Boards, Memorandum of Understanding, “The Norwalk Agreement,” (September 18, 2002) (the 

“Norwalk Agreement”). (available at: http://www.fasb.org/news/memorandum.pdf) For further details, see IASB, 
21

Boards acknowledged their joint commitment to convergence. They also pledged to use their 

best efforts to develop, “as soon as practicable,” high quality, compatible accounting standards 

that could be used for both domestic and cross-border financial reporting. Most recently, in 

September 2008, the Boards issued a progress report and a timetable for the completion of joint 

major projects by 2011 in areas such as financial statement presentation, revenue recognition, 

lease accounting, liabilities and equity distinctions, consolidation accounting, and pension and 

post-retirement benefit accounting.43 

 

The Commission recognizes the increasingly global nature of the capital markets and has long 

expressed its support for a single set of high-quality global accounting standards to benefit both 

U.S. and global capital markets and U.S. and foreign investors by facilitating comparison of 

financial information.44 To further this goal, the SEC has taken the following steps: 

• In December 2007, the SEC published rules to accept from foreign private issuers in their 

filings with the Commission, financial statements prepared in accordance with IFRS as 

issued by the IASB without reconciliation to U.S. GAAP.45 

• In November 2008, the Commission published for comment a proposed roadmap for the 

potential use of financial statements prepared in accordance with IFRS as issued by the IASB 

by U.S. issuers for purposes of their filings with the Commission.46 This proposed roadmap 

sets forth seven milestones that, if achieved, could lead to the required use of IFRS by U.S. 

issuers in 2014 if the Commission believes it to be in the public interest and for the 

protection of investors. In addition, the Commission also proposed to permit early use of 

IFRS, beginning with filings in 2010, by a limited number of U.S. issuers where this would 

enhance the comparability of financial information to investors. 

In light of these developments, the U.S. standard-setting process and changes to U.S. GAAP are 

intertwined with those abroad. Accordingly, where relevant, this study includes discussion of 

international considerations and events. For example, Section I.D of this study provides 

information about fair value accounting under IFRS, while Section VII discusses the accounting 

developments in response to the current global economic crisis from a global perspective and 

recommends modifications that should be coordinated with the IASB, as well as national and 

regional securities regulators. 

 A Roadmap for Convergence between IFRSs and US GAAP—2006-2008, Memorandum of Understanding between 

the FASB and the IASB, February 27, 2006. (available at: http://www.iasb.org/NR/rdonlyres/874B63FB-56DB4B78-B7AF-49BBA18C98D9/0/MoU.pdf) 

43 See the Boards’ update to the 2006 Memorandum of Understanding, Completing the February 2006 Memorandum 

of Understanding: A Progress Report and Timetable for Completion, September 2008. (available at: 

http://www.fasb.org/intl/MOU_09-11-08.pdf) 

44 See, e.g., SEC Release No. 33-6807 (November 14, 1988), Regulation of International Securities Markets. 

45 See SEC Release No. 33-8879 (December 21, 2007), Acceptance from Foreign Private Issuers of Financial 

Statements Prepared in Accordance with International Financial Reporting Standards without Reconciliation to U.S. 

GAAP. 

46 See Proposed Roadmap. 
22

D. Background Information on Fair Value Accounting 

The purpose of this section is to provide an understanding of the definition of fair value in 

accounting, the application of fair value accounting, a historical context for fair value 

accounting, and information about other measurement bases used in accounting. 

1. Definition of Fair Value 

a. U.S. GAAP 

 

As previously mentioned, fair value measurement is defined by SFAS No. 157, which was issued 

in 2006. SFAS No. 157 became effective at the beginning of 2008 for all reporting entities, with 

early adoption permitted.47 Prior to the issuance of SFAS No. 157, fair value measurement 

principles were not consistently defined and codified in a single accounting standard, which led 

to the potential for disparate fair value measurement practices under different accounting 

standards. SFAS No. 157 defines fair value, establishes a framework for measuring fair value, 

and expands disclosures about fair value measurements.48 Accordingly, SFAS No. 157 was 

issued to provide a single set of measurement principles to be uniformly applied for fair value 

measurement when U.S. GAAP requires or permits reporting entities to measure and / or disclose 

the fair value of an asset or a liability. Importantly, SFAS No. 157 did not change which assets 

and liabilities are subject to fair value accounting or when fair value should be applied. As noted 

in Section I.D.2 of this study, other previously existing accounting standards provide the 

requirement or permission to measure assets and liabilities at fair value. 

SFAS No. 157 defines “fair value” as follows: 

Fair value is the price that would be received to sell an asset or paid to transfer a liability 

in an orderly transaction between market participants at the measurement date.49

Key principles underpinning the definition of fair value under SFAS No. 157 are as follows: 

• Fair value is based upon an exchange price. Specifically, SFAS No. 157 highlights that the 

concept of fair value is based on an exit price notion (the price to be received on sale of an 

asset or price to be paid to transfer a liability) from a hypothetical exchange transaction. 

• The exchange price is the price in an orderly transaction which allows for due diligence, and 

is not from a distressed sale or a forced transaction. 

 

47 SFAS No. 157 was effective for financial statements issued for fiscal years beginning after November 15, 2007, 

and interim periods within those fiscal years. Delayed application was permitted for non-financial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a 

recurring basis (at least annually), until fiscal years beginning after November 15, 2008, and interim periods within 

those fiscal years. See SFAS No. 157, paragraph 36. 

48 See SFAS No. 157, paragraph 1. 

49 SFAS No. 157, paragraph 5. 
23

• Fair value measurement assumes that the asset is sold in its principal market or, in the 

absence of a principal market, the most advantageous market. 

• Fair value is determined based on the assumptions that market participants50 would use in 

pricing the asset or liability. A fair value measurement should include an adjustment for risk 

if market participants would include one in pricing the related asset or liability, even if the 

adjustment is difficult to determine. 

• Company-specific information should be factored into fair value measurement when relevant 

information is not observable in the market.51

• SFAS No. 157 provides a hierarchy for inputs used in fair value measurement based on the 

degree to which the inputs are observable in the market. Level 1 in the hierarchy includes 

inputs that are based on quoted prices in active markets for the identical asset or liability 

(“Level 1”). Level 2 includes quoted prices of similar instruments in active markets, quoted 

prices for identical or similar instruments in inactive markets, and observable market 

information on valuation parameters or market-corroborated information (“Level 2”), and 

Level 3 represents measurements that incorporate significant unobservable inputs that reflect 

the reporting entity’s own assumptions regarding valuation parameters that market 

participants would use (“Level 3”). Valuation techniques used to measure fair values should 

maximize the use of relevant observable inputs and minimize the use of unobservable inputs. 

When Level 1 inputs are available, those inputs should generally be used. 

• Companies measuring the fair value of their own liabilities should incorporate the effect of 

their credit risk (credit standing) on the fair value of their liabilities. For example, declines in 

a company’s own creditworthiness will generally result in a decrease in the fair value of the 

company’s own liabilities, all else being equal. 

b. IFRS 

Currently, under IFRS, “guidance on measuring fair value is dispersed throughout [IFRS] and is 

not always consistent.”52 However, as discussed in Section VII.B, the IASB is developing an 

exposure draft on fair value measurement guidance. 

IFRS generally defines fair value as “the amount for which an asset could be exchanged, or a 

liability settled, between knowledgeable, willing parties in an arm’s length transaction” (with 

 

50 Market participants are knowledgeable and informed buyers and sellers in the relevant market, who are 

independent of the reporting entity and are able and willing to transact for the asset or liability that is subject to fair 

value measurement. See SFAS No. 157, paragraphs 10-11. 

51 Company-specific information factored into fair value measurement should reflect the company’s expectation 

regarding market participant assumptions. 

52 IASB Discussion Paper, Fair Value Measurements, Part I – Invitation to Comment and Relevant IFRS Guidance 

(November 2006) (“Fair Value Discussion Paper”), paragraph 6. 
24

some slight variations in wording in different standards).53 While this definition is generally 

consistent with SFAS No. 157, it is not fully converged in the following respects: 

• The definition in SFAS No. 157 is explicitly an exit price, whereas the definition in IFRS is 

neither explicitly an exit price nor an entry price. 

• SFAS No. 157 explicitly refers to market participants, which is defined by the standard, 

whereas IFRS simply refers to knowledgeable, willing parties in an arm’s length transaction. 

• For liabilities, the definition of fair value in SFAS No. 157 rests on the notion that the 

liability is transferred (the liability to the counterparty continues), whereas the definition in 

IFRS refers to the amount at which a liability could be settled.54

2. Application of Fair Value Accounting 

Under both U.S. GAAP and IFRS, fair value is most prevalently used to measure “financial” 

assets and liabilities,55 as opposed to “non-financial” assets and liabilities, such as property or 

intangible assets. Financial assets and liabilities include, but are not limited to, investment 

securities, derivative instruments, loans and other receivables, notes and other payables, and debt 

instruments issued. Not all of these financial assets and liabilities are required to be measured at 

fair value; some are permitted to be measured at fair value because of provisions that generally 

permit an entity to elect fair value accounting for financial assets and liabilities. As noted in 

Section I.B.2, for those assets and liabilities that are measured at fair value, some have 

unrealized changes in fair value recognized through income and some have unrealized changes 

in fair value recognized in OCI in the equity section of the balance sheet. 

Fair value measurements that are required on a quarterly basis (or each reporting period) are 

often referred to as “recurring,” while fair value measurements that are required only if assets are 

considered impaired are considered to be “non-recurring.” Recurring fair value measurements 

apply to certain classes of investment securities and derivatives instruments, among other items. 

Non-recurring fair value measurements apply to various types of assets, both financial and nonfinancial, that are required to be tested for impairment in their value and, if impaired, are 

required to have their carrying amounts written down to fair value. 

The discussion below further explains how fair value accounting impacts both financial and nonfinancial assets and liabilities under U.S. GAAP and, as a comparison, highlights the more 

 

53 Ibid. 

54 See Ibid. 

55 Under U.S. GAAP, a financial asset is defined as “[c]ash, evidence of an ownership interest in an entity, or a 

contract that conveys to one entity a right (1) to receive cash or another financial instrument from a second entity or 

(2) to exchange other financial instruments on potentially favorable terms with the second entity.” A financial 

liability is defined as “[a] contract that imposes on one entity an obligation (1) to deliver cash or another financial 

instrument to a second entity or (2) to exchange other financial instruments on potentially unfavorable terms with 

the second entity” (SFAS No. 159, paragraph 6). The definition of financial assets and financial liabilities under 

IFRS is substantially converged to U.S. GAAP (International Accounting Standard (“IAS”) 32, Financial 

Instruments: Presentation, paragraph 11). 
25

significant differences in the treatment under IFRS. Others have pointed out the complexity of 

the current accounting requirements.56

a. How Fair Value Impacts Accounting for Financial Instruments

i. U.S. GAAP 

This section provides further information about different types of financial instruments and the 

extent to which fair value measurement is applied to those instruments. The extent to which U.S. 

GAAP requires financial instruments to be measured at fair value with changes in fair value 

recognized in income generally depends on the characteristics of the financial instrument, the 

legal form, and how the company intends to use the financial instrument. Measurement of 

financial instruments at fair value is also determined in some circumstances by the industry in 

which the reporting entity operates. For certain specialized industries like brokers and dealers in 

securities and investment companies (including mutual funds), fair value measurement has long 

been used for financial instruments.57

To the extent that financial assets are not measured at fair value each reporting period through 

income, companies are required to assess whether those financial assets are impaired. 

Impairment accounting can be complex, as there are different definitions of impairment and 

different impairment tests for different types of financial assets. Impairment accounting is 

summarized at the end of this subsection. 

Equity Securities

Investments in equity securities (e.g., an investment in common stock) may be accounted for in a 

number of different ways. Equity investments that provide a company with controlling financial 

interest generally result in the consolidation of the investee, such that the investee’s underlying 

assets and liabilities are accounted for based on their nature (e.g., cash, investments, property, 

and debt).58 For example, an entity that owns 80% of the equity securities of another entity and 

has voting control would consolidate the accounts of the controlled entity. 

Investments in equity securities of an entity over which a company has significant influence are 

presented on one line and accounted under the “equity method.” Equity method accounting is 

often viewed as a form of historical cost accounting in which the pro rata share of the operations 

of the investment is reflected in a “one line” consolidation of the books of the investee. These 

equity method investments are also subject to write-downs to fair value, but only when the 

 

56 See, e.g., IASB Discussion Paper, Reducing Complexity in Reporting Financial Instruments (March 2008), and 

Final Report of CIFiR (August 1, 2008) (“CIFiR Final Report”). (available at: 

http://www.sec.gov/about/offices/oca/acifr/acifr-finalreport.pdf) 

57 See American Institute of Certified Public Accountants (“AICPA”) Audit and Accounting Guide – Brokers and 

Dealers in Securities, Chapter 7, paragraph 2 (with conforming changes as of May 1, 2007), and Section 2(a)(41) of 

the Investment Company Act. 

58 See Accounting Research Bulletin No. 51, Consolidated Financial Statements. 
26

impairment is other-than-temporary.59 Alternatively, a company has the option to measure 

equity method investments at fair value, as discussed in further detail below.60

All other investments in equity securities for which fair value is readily determinable are 

measured at fair value. However, changes in fair value may be recognized either in income or in 

OCI, based on an election made by management. Changes in the fair value of securities that 

management has classified as trading are required to be recognized in income each period. 

Changes in the fair value of securities that management has classified as AFS, which represent 

all other equity securities, are required to be recognized in OCI each period, until the investment 

is ultimately sold or impairment in the security is determined to be other-than-temporary.61 

It is possible to transfer equity securities into or out of the trading classification; however, U.S. 

GAAP indicates that such circumstances should be rare. 

Equity securities for which fair value is not readily determinable are generally measured at cost, 

with adjustments only made when the decline in the estimated fair value below cost is considered 

other-than-temporary.62 

Debt Securities

Investments in debt securities may also be accounted for in a number of different ways.63 

Investments classified as trading are required to be measured at fair value each period, with all 

changes in fair value recognized in income each period. In rare circumstances, companies can 

reclassify debt securities into or out of the trading classification. 

Debt securities that a company purchases with the strict intent and ability to hold until maturity 

may be designated as held-to-maturity (“HTM”). In limited circumstances, companies can sell 

HTM debt securities or transfer those securities out of the HTM classification. HTM securities 

are recorded on the balance sheet at amortized cost. Declines in fair value are not reported in the 

balance sheet or income statement, except when the security value is impaired (the carrying 

amount is above fair value) and the impairment is determined to be other-than-temporary. 

Investments that a company does not choose to designate as trading or HTM are classified as 

AFS. AFS securities are recorded on the balance sheet at fair value; however, unrealized 

 

59 See Accounting Principles Board (“APB”) Opinion No. 18, The Equity Method of Accounting for Investments in 

Common Stock. 

60 See SFAS No. 159. 

61 See SFAS No. 115. 

62 See FSP FAS No. 115-1 / 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to 

Certain Investments (“FSP FAS 115-1 / 124-1”). 

63 See SFAS No. 115; Emerging Issues Task Force (“EITF”) Issue No. 99-20, Recognition of Interest Income and 

Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in 

Securitized Financial Assets (“EITF Issue No. 99-20”); SFAS No. 5, Accounting for Contingencies (“SFAS No. 5”); 

SFAS No. 114, Accounting by Creditors for Impairment of a Loan (“SFAS No. 114”); Statement of Position 

(“SOP”) 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer (“SOP 03-3”). 
27

changes in fair value are generally not recorded in the income statement. Rather, changes in the 

fair value of AFS securities are required to be recognized in OCI each period, until the 

investment is ultimately sold or impairment in the security is determined to be other-thantemporary. Reclassifications from AFS to HTM are permitted, provided that the company has 

the positive intent and ability to hold the security to maturity. 

Securitized Assets

Some assets undergo a process, referred to as securitization, by which the assets are transformed 

into securities.64 While both financial and non-financial assets can be securitized, it is more 

commonly observed for financial assets. In a typical securitization, a company transfers a 

portfolio of financial assets, such as mortgage loans, automobile loans, student loans, credit card 

receivables, or other assets, into a trust or other form of “special purpose entity.” The special 

purpose entity then issues interests in the underlying assets to investors. The interests are often 

issued in different classes, with different risks and payoffs for the investors.65 A holder of an 

interest in a securitization would follow the accounting requirements for either debt or equity 

securities depending on the characteristics of the interest held. 

One unique aspect of accounting for interests in securitized financial assets is the accounting for 

impairment (summarized at the end of this subsection). 

Direct Investments in Loans

The accounting for a direct investment in a loan (as opposed to a debt security) varies based on 

whether the loan is held-for-investment (“HFI”) or held-for-sale (“HFS”). Generally, HFI loans 

are accounted for at amortized cost, with impairment recognized only for probable credit losses. 

Recognition of probable credit losses differs significantly from fair value losses in that the 

measurement of loss incorporates only expected delays in the timing and amount of expected 

cash flows that are due to events that have been incurred as of the measurement date (incurred 

credit losses). 

HFS loans (e.g., loans made with the intent to package and securitize) are reported at the lowerof-cost-or-fair-value, with declines in fair value recognized in income.66 Losses recognized for 

declines in the fair value of loans include the impact of all market factors, including changes in 

expected cash flows, risk premiums, and liquidity. 

Companies can transfer loans into or out of the HFS classification as a result of changes in 

intentions regarding whether the loans will be sold or HFI. 

Alternatively, a company may elect to measure its loans at fair value, as discussed further below, 

regardless of whether they are HFI or HFS.67 

 

64 See SFAS No. 140, Glossary. 

65 See Ibid., paragraphs 73-75. 

66 See SFAS No. 65; SFAS No. 5; SFAS No. 114; and SOP 03-3. 

67 See SFAS No. 159. 
28

Derivative Assets and Liabilities

Derivatives, as defined in SFAS No. 133 and related guidance, are required to be reported on a 

company’s balance sheet at fair value. The basis for conclusions in SFAS No. 133 states that: 

The Board believes fair value is the only relevant measurement attribute for derivatives. 

Amortized cost is not a relevant measure for derivatives because the historical cost of a 

derivative often is zero, yet a derivative generally can be settled or sold at any time for an 

amount equivalent to its fair value.68 

Common types of financial instruments that are accounted for as derivatives include interest rate, 

commodity, foreign exchange, and credit-default swap and forward contracts. 

SFAS No. 133 also provides special accounting treatment for derivatives that are designated and 

qualify as hedges. Changes in the fair value (unrealized gains and losses) of derivative contracts 

that are not designated as a hedge are recorded directly in income. For derivatives that are 

designated as hedges of future cash flows (“cash flow hedges”), the changes in the fair value of 

those derivatives are not immediately recorded in income. Rather, changes in fair value are 

initially recorded in the accumulated OCI section of the shareholder’s equity portion of the 

balance sheet and then reclassified into income when the related cash flows (the cash flows being 

hedged) impact income. For derivatives that are designated as hedges of changes in the fair 

value of a recognized asset or liability (“fair value hedges”), changes in the fair value of the 

derivative, together with the offsetting change in the fair value of the hedged item, are 

recognized immediately in income. Thus, to the extent that the hedge is effective, the impact in 

income is offset. 

Other Financial Liabilities

Currently, U.S. GAAP generally only requires derivative liabilities to be measured on a recurring 

basis at fair value. However, SFAS No. 159 provides companies with an option to elect to fair 

value certain financial liabilities, as discussed further below. 

As fair value is defined in SFAS No. 157, if an entity elects fair value (or, in the case of 

derivative liabilities, fair value is required), the fair value is measured based on a transfer notion 

as opposed to a settlement notion. That is, the fair value of a liability is based on how much it 

would cost a company to pay another market participant to assume its liability. The nonperformance risk (the risk of borrower default) should be the same before and after the transfer. 

This measurement requires companies to include changes in creditworthiness of the borrower in 

the fair value of the liability. A decline in the creditworthiness of a company results in the 

recognition of a gain in the income statement as the fair value of the liability declines. 

 

68 SFAS No. 133, paragraph 223. 
29

Fair Value Option

In recent years, the FASB has included a “fair value option” (“FVO”) in several standards, which 

permits, but does not require, reporting entities to make elections to measure certain assets and / 

or liabilities at fair value. In 2006, the FASB issued SFAS No. 155 and SFAS No. 156. Both of 

these standards permit fair value elections in certain circumstances.69 In 2007, the FASB issued 

SFAS No. 159. SFAS No. 159 expanded the ability of reporting entities to elect fair value 

measurement for most financial assets and liabilities, with unrealized changes in fair value 

reported in earnings and thereby impacting net income. The FASB stated the objective of SFAS 

No. 159 as follows: 

This Statement permits entities to choose to measure many financial instruments 

and certain other items at fair value that are not currently required to be measured 

at fair value. The objective is to improve financial reporting by providing entities 

with the opportunity to mitigate volatility in reported earnings caused by 

measuring related assets and liabilities differently without having to apply 

complex hedge accounting provisions. This Statement is expected to expand the 

use of fair value measurement, which is consistent with the Board’s long-term 

measurement objectives for accounting for financial instruments. In addition, it is 

similar to a measurement choice permitted in International Financial Reporting 

Standards.70

While SFAS No. 159 provides an “option,” the FASB set parameters around application of the 

FVO. A reporting entity’s decision about whether to elect the FVO: (1) is applied on an 

instrument-by-instrument basis, with certain limited exceptions, (2) is irrevocable (once selected 

for an individual instrument) and therefore cannot be changed subsequent to election, and (3) is 

applied only to an entire instrument and not to only specified risks, specific cash flows, or a 

portion of that instrument.71 When specifying that the FVO may be elected on an instrument by 

instrument basis, the FASB noted that the option may be elected for a single eligible item 

without electing it for other identical items, with certain limited exceptions.72 

SFAS No. 159 became effective at the beginning of 2008 for calendar-year entities, with early 

adoption allowed in 2007 in certain circumstances.73 Reporting entities could elect the FVO for 

 

69 SFAS No. 155 permits fair value remeasurement for any hybrid financial instrument that contains an embedded 

derivative that otherwise would require bifurcation. SFAS No. 156 permits an entity to elect to subsequently 

measure its servicing assets and servicing liabilities at fair value, by class. 

70 SFAS No. 159, paragraph 1. 

71 See SFAS No. 159, paragraph 5. 

72 See SFAS No. 159, paragraph 12. The exceptions involve multiple advances made to one borrower pursuant to a 

single contract; investments that would otherwise be accounted for under the equity method of accounting; eligible 

instruments or reinsurance contracts; and insurance contracts with integrated or nonintegrated contract features or 

coverages. 

73 SFAS No. 159 became effective as of the beginning of each reporting entity’s first fiscal year that began after 

November 15, 2007. See SFAS No. 159, paragraph 24. An entity was permitted to adopt the standard and elect the 

FVO for existing eligible items as of the beginning of a fiscal year that begins on or before November 15, 2007. See 

SFAS No. 159, paragraph 30. 
30

individual financial instruments that existed upon initial adoption of SFAS No. 159 and for new 

financial instruments when acquired. 

Impairments

The accounting for impairments of financial assets not subject to mark-to-market accounting 

developed over many years on a standard-by-standard basis and differs depending upon the 

characteristics, form, and intended use of the financial asset. For example, an HFI loan is 

generally impaired when it is probable that a creditor will be unable to collect all amounts due.74 

Measurement of loan impairment is based on management’s estimate of incurred credit losses 

and is accounted for using a valuation allowance, often referred to as an allowance for credit 

losses, with changes in the estimated valuation allowance recognized in income. In contrast, a 

debt or equity security is generally considered impaired when its carrying amount (generally 

based on amortized cost) exceeds its fair value.75 As noted earlier, fair value incorporates 

assumptions that market participants would use in pricing the asset, including those related to 

general interest rates, credit spreads, and liquidity. 

For impaired debt or equity securities, only impairments that are considered to be “other-thantemporary” (referred to as “other-than-temporary impairment” or “OTTI”) result in a 

remeasurement at current fair value, with the change in fair value recognized in income. 

Judgment is required in assessing whether an OTTI exists. Some of the factors that companies 

consider in evaluating whether an OTTI exists include: the length of the time and the extent to 

which the fair value has been less than its carrying amount; the financial condition and prospects 

of the issuer; and the intent and ability of the holder to retain its investment in the issuer for a 

period of time sufficient to allow for any anticipated recovery in fair value.76 U.S. GAAP 

generally mandates that subsequent to recording an impairment loss, further increases in the fair 

value of an asset are not reflected in income until the asset is sold. 

The current global economic crisis has highlighted difficulties in performing OTTI evaluations.77 

As required by SFAS No. 115, a company that classifies securities as either HTM or AFS must 

determine whether a decline in fair value below the amortized-cost basis is other-than-temporary. 

There are basically three steps in determining if a company is required to take an OTTI charge to 

income, including: (1) calculating the fair value of a security, (2) determining if a decline in fair 

value is due to a credit related event, and (3) assessing whether or not the investor has the ability 

and intent to hold the security until recovery. The current market environment has posed several 

challenges for preparers as it relates to the calculation of the fair value of certain financial 

instruments (e.g., certain Level 2 and Level 3 assets). Furthermore, preparers have struggled 

 

74 See SFAS No. 114, paragraph 8. 

75 See SFAS No. 115, paragraph 16. 

76 See Staff Accounting Bulletin Topic 5M, Other Than Temporary Impairment of Certain Investments in Debt and 

Equity Securities. See also FSP FAS 115-1 / 124-1. 

77 See, e.g., letters from ABA (November 13, 2008), MassMutual, Citi, CAQ, Nationwide, ACLI, and FHLBC. 
31

with the multiple models that exist to determine if a decline in fair value is other-thantemporary.78

Under U.S. GAAP, a debt security is subject to an assessment of OTTI under SFAS No. 115 

with a subset of debt securities (interests in securitized financial assets) requiring incremental 

procedures under EITF Issue No. 99-20.79 If a security is impaired for credit concerns utilizing 

one of these models, the security is written down to current fair value and an expense is recorded 

in the income statement. However, complexity exists regarding the determination of which 

model should be utilized to determine if a credit-based impairment exists and the different 

recognition thresholds required under each model. 

In determining whether an impairment is other-than-temporary, EITF Issue No. 99-20 requires a 

preparer to test for an adverse change in cash flows by using its best estimate of the cash flows 

that a market participant would use in determining the fair value. In contrast, for securities not 

within the scope of EITF Issue No. 99-20, there is no similar requirement to use a market 

participant’s view. While on the surface this distinction may seem minor, EITF Issue No. 99-

20’s requirement to utilize market participant cash flows as compared to management’s own 

internal estimates under SFAS No. 115, combined with the substantial decline in the fair value of 

various securities in the current market environment, has resulted in substantial disparity in the 

application of the models in practice and has reduced the comparability of financial statements. 

To address these issues, on December 19, 2008, the FASB issued an exposure draft of FSP EITF 

99-20-a, Amendments to the Impairment and Interest Income Measurement Guidance of EITF 

99-20 (“FSP EITF 99-20-a”), that would remove the requirement to use market participant 

assumptions for purposes of testing for OTTI. 

 

Section VII.A of this study provides further information about recent FASB activities in this 

area. 

ii. IFRS 

As it relates to the application and use of fair value, IFRS differs from U.S. GAAP in its 

accounting for financial instruments most significantly in the following respects: 

• IFRS does not distinguish between investments that are in the form of debt securities and 

those that are investments in loans. Under IFRS, regardless of the form, investments in 

obligations with fixed or determinable payments generally can be accounted for as loans, if 

 

78 See, e.g., letter from BDO Seidman, LLP to the FASB, dated November 17, 2008, as input to the FASB and 

IASB’s November 25, 2008 Round Table Meeting on the Global Financial Crisis (available at: 

http://72.3.243.42/board_handouts/11-25-08_Joint_FASB_IASB_Roundtable_Global_Financial_Crisis.pdf), which 

states: 

U.S. GAAP has four different impairment models for economically similar fixed income investments: FAS 

5/FAS 114 for loans, SOP 03-3 for loans purchased with known deterioration in collectibility since origination, 

EITF Issue 99-20 for retained interests in securitizations, and FAS 115 other-than-temporary impairment for 

debt securities. 

79 SOP 03-3 provides additional guidance regarding OTTI for acquired securities. The guidance in SOP 03-3 

utilizes aspects of both SFAS No. 115 and EITF Issue No. 99-20. 
32

the investments do not trade in an active market and the holder does not intend to sell the 

investment in the near term.80 Similar to U.S. GAAP, accounting for investments not 

classified as loans is based on whether the investment is classified as trading, AFS, or HTM. 

• Prior to recent IASB amendments in October 2008, IFRS had more restrictive requirements 

than U.S. GAAP about transferring certain financial assets. Subsequent to these 

amendments, which are retroactively effective to July 1, 2008, non-derivative financial assets 

held for trading and AFS financial assets may be reclassified under IFRS in particular 

situations,81 as discussed in greater detail in Section VII.A. 

• Under IFRS, the trigger for recognizing impairment differs from U.S. GAAP, resulting in the 

potential for differences in the timing of when an impairment charge is recorded. 

• Measurement of impairment losses differs under IFRS for HTM securities, which are written 

down through income under both U.S. GAAP and IFRS. However, under U.S. GAAP, these 

securities are written down to fair value; under IFRS, they are written down only for incurred 

credit losses. 

• IFRS has greater restrictions on the use of the option to elect fair value accounting. 

b. How Fair Value Impacts Accounting for Non-Financial 

Instruments 

i. U.S. GAAP 

Non-financial assets and liabilities generally are not accounted for at fair value on a recurring 

basis. Currently, non-financial assets and liabilities are generally initially measured at their cost 

or based upon proceeds received (which many would view to be generally in line with fair 

value). In addition, U.S. GAAP provides for many non-financial assets to be written down to 

their current value when those assets are determined to be impaired. If the fair value of those 

assets subsequently increases, the assets are generally not marked up to the new fair value. A 

description of U.S. GAAP requirements that include non-recurring fair value measurements for 

non-financial assets and liabilities is provided below. 

Business Combinations

SFAS No. 141, Business Combinations (“SFAS No. 141”), was issued in June 2001.82 Though 

this standard provides guidance on how to account for business acquisitions, it is significant from 

a fair value measurement standpoint because the acquirer is required to measure many of the 

 

80 See IAS 39, as amended, paragraph 9. 

81 See “IASB amendments permit reclassification of financial instruments,” IASB press release (October 13, 2008). 

82 SFAS No. 141(R), Business Combinations (“SFAS No. 141R”), was issued and will be effective for companies in 

fiscal years beginning after December 15, 2008. SFAS No. 141R supersedes SFAS No. 141 and further requires the 

use of fair value by requiring that most assets and liabilities acquired in an acquisition be measured at fair value. It 

also requires that any non-controlling interest in the acquiree be measured at fair value. 
33

assets and liabilities acquired in the business combination at fair value. However, there are many 

exceptions under SFAS No. 141 to the use of fair value upon initial recognition. Accordingly, 

while assets may be reported on a target’s books at historical cost, they are often remeasured to 

fair value upon acquisition. SFAS No. 141 also requires the identification and recognition of 

intangible assets at fair value. While SFAS No. 141 only requires fair value measurement on 

acquisition (and not on a recurring basis subsequent to the acquisition), this statement indicates 

the FASB’s view that fair value measurement is relevant not only for financial instruments, but 

also for certain transactions such as business combinations and for non-financial assets such as 

intangible assets that are acquired in such transactions.83

Goodwill

Although goodwill itself is not measured at fair value, it represents a residual amount after other 

amounts on the balance sheet have been measured at the date of acquisition. Goodwill must be 

tested for impairment annually or more frequently if certain triggering events occur. If the 

carrying amount of goodwill exceeds the residual amount from recognizing all other assets and 

liabilities on the balance sheet at the date of the impairment test, then goodwill must be written 

down to this revised residual amount, with the loss recognized in income.84 

Indefinite-Lived Intangible Assets

Like goodwill, indefinite-lived intangible assets are required to be tested for impairment annually 

or more frequently if certain triggering events occur. If the carrying value of the indefinite-lived 

intangible exceeds its fair value, it must be written down to the estimated fair value, with the loss 

recognized in income.85 

Other Long-Lived Assets

U.S. GAAP requires other long-lived assets, such as property, plant, and equipment, and finitelived intangible assets, to be written down to fair value, in certain circumstances (e.g., when the 

expected cash flows to be generated by an asset or group of assets are less than the carrying 

value). In addition, long-lived assets held-for-sale must be written down to fair value less costs 

to sell. These losses are recognized in income.86 

ii. IFRS 

IFRS differs from U.S. GAAP as it relates to the use of fair value for non-financial instruments 

in two primary respects. First, IFRS provides a FVO for non-financial assets such as property, 

plant, equipment, and investment property, but does not do so for mortgage servicing rights 

(“MSRs”), as permitted under U.S. GAAP.87 Second, IFRS requires reversal of impairment 

 

83 See, e.g., SFAS No. 141, paragraph B171. 

84 See SFAS No. 142, Goodwill and Other Intangible Assets. 

85 See Ibid. 

86 See SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS No. 144”). 

87 See IAS 16, Property, Plant and Equipment; and IAS 40, Investment Property. 
34

losses (when and if the value of an asset recovers) on non-financial assets other than goodwill in 

certain circumstances.88 

3. Historical Context for Fair Value Accounting 

Early-Twentieth Century through the Great Depression

Prior to the development of mandatory accounting standards following the Great Depression, 

companies had significant latitude in selecting their own accounting practices and policies. 

There is evidence that the use of “current values” or “appraised values” for assets, and the 

recording of upward asset revaluations, were common in the early-twentieth century in the 

period prior to the Depression. During this period, balance sheets often included upward 

revaluations of long-term assets such as property, plant, equipment, and intangible assets. For 

example, a survey of 208 large industrial firms between 1925 and 1934 revealed that 75% of the 

sample firms recorded upward or downward asset revaluations during this period, including 70 

write-ups of property, plant, and equipment, seven write-ups of intangibles, and 43 write-ups of 

investments.89 Further, prior to 1938, banking organizations were required for supervisory 

purposes to use market value accounting for their investment securities portfolios. Serious 

concerns on the part of the U.S. Treasury and the bank regulators over how this affected the 

banks’ financial performance and investment decisions led the agencies to abandon in that year 

the use of this accounting concept for supervisory purposes.90 

In the aftermath of the Great Depression, there was a general move toward more “conservative” 

accounting. This included a move away from the use of “current values” or “appraised values” 

for long-lived assets such as fixed assets and intangibles.91 This move away from “current 

value” accounting and towards the use of historic cost accounting for long-lived assets was 

strongly supported by Robert E. Healy, the first Chief Accountant of the SEC. Healy had 

participated in the Federal Trade Commission (“FTC”) investigation of business practices that 

preceded the formation of the SEC. This investigation uncovered widespread use of asset writeups which the FTC viewed as arbitrary. Commenting on the findings of this investigation, Healy 

is quoted as observing that “you can capitalize in some [s]tates practically everything except the 

furnace ashes in the basement.”92 During Healy’s tenure, the newly-formed SEC strongly 

 

88 See IAS 36, Impairment of Assets. 

89 See Solomon Fabricant, Revaluations of Fixed Assets, 1925-1934, National Bureau of Economic Research 

Bulletin (December 1936). As a counterpoint, however, a study by Kirsten Eli & Gregory Waymire, Intangible 

Assets and Stock Prices in the Pre-SEC Era, 37 Journal of Accounting Research (Supplement) (1999), at 17-44, 

found evidence of some firms adopting deliberately conservative accounting policies in this pre-regulatory period. 

For example, many firms (e.g., General Electric) wrote-down their intangible assets to nominal amounts, e.g., $1. 

For a further discussion, see Gregory Waymire & Sudipta Basu, Accounting is an Evolving Economic Institution, 

Foundations and Trends in Accounting (2008), Forthcoming. 

90 See, e.g., letter dated November 1, 1990, from Federal Reserve Chairman Alan Greenspan to SEC Chairman 

Richard Breeden. 

91 See R. G. Walker, The SEC’s Ban on Upward Asset Revaluations and the Disclosure of Current Values, 28 

Abacus 1 (1992), at 3-35. 

92 Joel Seligman, The Transformation of Wall Street: A History of the Securities and Exchange Commission and 

Modern Corporate Finance, 108 (3rd ed. 2003). 
35

endorsed historic cost accounting for long-lived assets and moved to curtail the use of “appraised 

values” through the registration process. By 1940, the practice of the upward revaluation of 

fixed assets – a practice that had been commonplace in the late 1920s – was virtually extinct 

from financial reporting in the U.S.93

Valuation of Securities

The use of fair value measurement expanded significantly in 1975, with the issuance of 

authoritative accounting literature that mandated its use in certain circumstances due to concerns 

about the appropriate measurement attribute for equity securities. Prior to 1975, there was a lack 

of consistency in accounting literature, which resulted in diversity in accounting practice, 

specifically with respect to marketable securities. Accounting practices included carrying such 

securities at cost, at market, and, in some cases, a combination of both measurements for 

different classes of securities. During 1973 and 1974, there were substantial declines in the 

market values of many securities. These declines, in many cases, were not reflected in financial 

reports. When the market recovered in 1975, the accounting guidance was unclear on whether 

securities previously written down could be written up to previous carrying amounts. As a result 

of these issues, the FASB issued SFAS No. 12, Accounting for Certain Marketable Securities, in 

December 1975, which required that all marketable equity securities be recorded at the lower-ofcost-or-fair-value. Debt securities continued to be accounted for at amortized cost.

Banking and Savings and Loan Crisis

The banking and savings and loan crisis of the 1980s exposed challenges with the historic cost 

model of accounting for financial institutions, as: 

...in the Savings and Loan Crisis in the U.S., historic cost accounting masked the [extent 

of the] problem by allowing losses to show up gradually through negative net interest 

income. It can be argued that a mark-to-market approach would have helped to reveal to 

regulators and investors that these institutions had problems. This may have helped to 

prompt changes earlier than actually occurred and that would have allowed the problem 

to be reversed at a lower fiscal cost.94

 

Specifically, savings and loan institutions accepted short-term deposits and used these deposits to 

fund long-term fixed-rate (e.g., 30-year) mortgage loans, their primary asset. In the late 1970s 

and early 1980s, interest rates were driven up by high inflation. Many savings and loans were 

then in a position where they had to pay a higher rate of interest on their deposits than they were 

earning on their existing fixed-rate mortgage loans. If these savings and loan institutions had to 

sell their mortgage assets, which yielded, for example, five percent, to repay their deposits that 

were currently yielding, for example, ten percent, they would have had to severely discount their 

mortgage assets (because the current market rate was ten percent rather than the five percent 

 

93 See Stephen Zeff, The SEC Rules Historic Cost Accounting: 1934 to the 1970s, 37 Accounting and Business 

Research (International Accounting Policy Forum Issue) (2007). 

94 Franklin Allen & Elena Carletti, Mark-to-Market Accounting and Liquidity Pricing, 45 Journal of Accounting and 

Economics, at 358-378. 
36

when their mortgages were originated). In some cases, the “current value” of their assets was 

less than the value of their liabilities, and these institutions were economically insolvent. 

However, under the historic cost accounting model, these losses were not reflected in their 

financial statements, with the effect of reducing transparency surrounding the solvency position 

of these institutions. This, in turn, created a moral hazard problem, whereby the management of 

economically less solvent institutions then had an incentive to take-on more risky investments 

(e.g., commercial real estate) in the hope that they could trade their way out of their current 

economically less solvent position. In effect, the historical-cost-based financial statements 

obscured underlying economic losses and allowed troubled financial institutions to go 

undetected. This led to various calls in the late 1980s and early 1990s for more use of market 

values in regulatory accounting for financial institutions.95 

Historical-cost-based financial statements also allowed financial institutions to engage in “gains 

trading.”96 With the greater interest rate volatility in the 1980s, financial institutions were 

increasingly in the position of holding assets or liabilities where the current market values of 

these financial instruments differed markedly from their historical cost values shown in their 

financial statements. In this situation management could opportunistically choose which assets 

to sell, or which liabilities to settle, in order to realize gains (or losses) in particular accounting 

periods. This afforded management a powerful income statement management tool.97 In 

addition, for financial institutions short of capital, this created an incentive for the management 

to sell their well-performing assets in order to realize gains to boost their capital, but retain their 

poorly-performing assets (which had unrealized losses). 

Changes in the Banking Model During the 1980s

The change in the business environment during the 1980s also provides the backdrop that is 

necessary to understand the progress of fair value accounting. Historically, many financial 

institutions did not have dynamic risk management strategies and would rarely sell investments 

before their maturity. Deregulation of interest rates during this period caused a change in the 

strategies of financial institutions, and securities positions were traded more actively. New 

financial instruments were created in response to changes in the market, such as deregulation, tax 

law changes, volatility, and other factors.98 U.S. GAAP for such changes in financial 

instruments was being developed on an issue-by-issue basis. For example, accounting literature 

issued included SFAS No. 52, Foreign Currency Translation, issued in 1981, which required fair 

value accounting for certain foreign exchange contracts through the income statement and SFAS 

 

95 See, e.g., Edward J. Kane, The Gathering Crisis in Federal Deposit Insurance (1985); Lawrence J. White, On 

Measurement of Bank Capital, 13 Journal of Retail Banking 2 (1991), at 27-34; and George Benston, Market Value 

Accounting: Benefits, Costs and Incentives, Proceedings of the Conference on Bank Structure and Competition, 

Chicago: Federal Reserve Bank of Chicago (1989), at 547-563. 

96 The FASB’s subsequent adoption of SFAS No. 115, requiring fair value accounting for most marketable securities 

was motivated, in part, by the desire to curtail such “gains trading.” See James Thompson, SFAS 115: A Victory for 

Fair Value Accounting, 39 National Public Accountant 10 (1994), at 21-30. 

97 See testimony of Richard C. Breeden, Chairman, SEC, before Committee of Banking, Housing and Urban Affairs 

of United States Senate on Issues Involving Financial Institutions and Accounting Principles (June 25, 1999). 

98 See SFAS No. 105, Disclosure of Information about Financial Instruments with Off-Balance-Sheet Risk and 

Financial Instruments with Concentrations of Credit Risks. 
37

No. 80, Accounting for Futures Contracts, issued in 1984, which required futures contracts that 

do not qualify for hedge accounting to be measured at fair value through income. 

FASB’s Financial Instruments Project

Due, in part, to the savings and loan crisis, the FASB recognized the need to develop disclosure 

and accounting requirements on a broader basis for all classes of financial instruments. The 

broader project was added to the FASB’s agenda in 1986 “to address financial reporting issues 

that were arising, or that were given a new sense of urgency, as a result of financial 

innovation.”99 A disclosure project was viewed as an interim step in addressing accounting 

issues surrounding such financial instruments and off-balance sheet financing. This project 

resulted in the issuance of SFAS No. 105, in March 1990, and SFAS No. 107, Disclosures about 

Fair Value of Financial Instruments (“SFAS No. 107”), in December 1991. 

The FASB continued its work on a second phase of the broader project of accounting for 

financial instruments to address issues of inconsistent literature, the perceived greater relevance 

of fair value information, gains trading practices, and the inequitable result of lower-of-cost-orfair-value accounting. This work resulted in the FASB issuing SFAS No. 115 in 1994. As 

previously described in this study, this statement requires companies to classify their investments 

in debt or equity securities as trading, AFS, or HTM, with different accounting models for each 

classification. 

In June 1997, the FASB issued SFAS No. 130, Reporting Other Comprehensive Income (“SFAS 

No. 130”). This statement was issued in response to user concerns that changes in certain assets 

and liabilities were being recorded directly in equity, bypassing the income statement. In an 

attempt to improve the transparency and prominence of such items, the FASB required that 

changes in equity needed to be reported individually and with the same prominence as other 

financial statements included in a full set of financial statements. Unrealized gains and losses on 

AFS securities were one category required to be so reported. The impact of SFAS No. 130 was 

to make changes in value of AFS securities – which continue to be excluded from income – more 

transparent. 

Expanded Use of Derivative Instruments in the 1990s

The historical cost accounting model was not well-suited to address the development and 

proliferation of derivative instruments. These instruments often involve little or no initial 

investment but, given the leveraged nature of the positions, subsequent changes in value can be 

dramatic. The historical accounting model did not appropriately capture the associated risks and 

uncertainties or subsequent changes in value. An increase in the use of derivatives, lack of 

transparency around their values, and major losses incurred by various entities as a result of 

investments in derivatives100 were factors that led the FASB to develop a new accounting 

 

99 SFAS No. 133, paragraph 207. 

100 See Thomas R. Weirich & Lynn E. Turner, What’s New in Derivative Regulation, 6 The Journal of Corporate 

Accounting and Finance 1 (Autumn 1994) at 1-16. Exhibit 2 in the article presents, “Major Losses due to Derivative 

Activity,” including $1 billion losses for Metallgesellschaft and Proctor & Gamble Co. 
38

standard on derivative instruments, resulting in the issuance of SFAS No. 133 in June 1998.101 

As noted previously in this study, SFAS No. 133 requires that all derivatives be accounted for at 

fair value on the balance sheet (with minor exceptions). Changes in the fair value of the 

derivatives are to be recorded in income unless the derivatives qualify for special accounting 

treatment known as hedge accounting. 

4. Other Measurement Bases 

a. Description of Other Measurement Bases 

For the purpose of this discussion, measurement (the basis given for purposes of accounting) 

refers to both the initial measurement of an asset or liability and subsequent measurement, 

including revaluations, impairment, and depreciation. As noted above, fair value is only one of 

several measurement bases currently used in the mixed-attribute accounting model. Other 

measurement bases used in current accounting practice include:102 

• Historical cost 

• Current cost 

• Net realizable value 

• Present value of future cash flows 

This list is not intended to be exhaustive. Some aspects of the measurement bases listed above 

could be disputed (e.g., the present value of future cash flows could be considered a 

measurement technique rather than a measurement basis per se). Other bases arguably could 

also be added (e.g., deprival value, which is the loss that an entity would suffer if it were 

deprived of an asset), but such other bases would typically be defined by reference to or hold 

attributes in common with the measurement bases listed.103 

The Boards have been engaged in ongoing work to identify, define, and evaluate potential 

measurement bases in order to draw conceptual conclusions regarding their appropriateness in 

future standard-setting projects. Below, brief descriptions of the measurement bases listed above 

as used in current practice is provided, followed by discussion of the Boards’ ongoing work 

regarding potential measurement attributes. Section VI.B further discusses issues related to 

identifying appropriate measurement bases. 

 

101 See SFAS No. 133, Background Information and Basis for Conclusions, especially paragraph 212, and United 

States General Accounting Office, Report to Congressional Requesters, Financial Derivatives: Actions Needed to 

Protect the Financial System (May 1994) 

102 See SFAC No. 5, paragraph 67. 

103 See IASB Discussion Paper, Measurement Bases for Financial Accounting – Measurement on Initial 

Recognition, prepared by the staff of the Canadian Accounting Standards Board (November 17, 2005), paragraphs 

71, 73, and 94. 
39

Historical Cost 

Historical cost (or historical proceeds) is the amount of cash, or its equivalent, paid to acquire an 

asset or received when an obligation is incurred.104 After initial measurement, it is often adjusted 

for impairment, depreciation, amortization or other allocations (e.g., historical cost less 

accumulated depreciation). Some have observed that the term “historical exchange price” may 

be more descriptive than “historical cost.” While such terms describe the measurement basis for 

many classes of assets (e.g., most inventory, property, equipment), it is less fitting for other 

classes of assets and liabilities (e.g., deferred income tax assets, warranties payable).105 

Current Cost

Current cost broadly refers to the amount of cash or its equivalent currently required to replace 

the asset with an identical one or one with equivalent productive capacity or service potential.106 

Some inventories are reported at current cost. Variations of current cost include replacement 

cost and reproduction cost. 

Net Realizable Value

Net realizable value, sometimes referred to as settlement value, is the non-discounted amount of 

cash, or its equivalent, expected to be derived from the sale of an asset, net of selling costs and 

costs to complete, as well as the non-discounted amount of cash, or its equivalent, that is 

expected to be paid to liquidate an obligation in the due course of business. Examples of items 

where this measure is utilized include short-term receivables, trade payables, and warranty 

obligations.107

Present Value of Future Cash Flows

Present value of future cash flows refers to the present or discounted value of estimated future 

net cash flows, generally as expected to arise from an asset or to satisfy a liability in due course 

of business.108 Long-term receivables and payables are examples of items that incorporate the 

concept of discounted cash flows. This definition is similar to the concept of fundamental value 

or value-in-use,109 which would also take into account the entity’s internal information about the 

likely performance of the asset, such as its ability to extract above average net cash flows from 

 

104 See SFAC No. 5, paragraph 67a. 

105 See SFAC No. 5, paragraphs 68-69. 

106 See SFAC No. 5, paragraph 67b; and IASB Discussion Paper, Measurement Bases for Financial Accounting – 

Measurement on Initial Recognition, prepared by the staff of the Canadian Accounting Standards Board (November 

17, 2005), paragraph 320. 

107 See SFAC No. 5, paragraph 67d. 

108 See SFAC No. 5, paragraph 67e. 

109 See SFAC No. 7, Using Cash Flow Information and Present Value in Accounting Measurements (“SFAC No. 

7”), paragraph 24b; and IFRS 5A, Non-current Assets Held for Sale and Discontinued Operations (“IFRS 5A”). 
40

an asset. Under IFRS, value-in-use is used, for example, to determine the recoverable amount in 

accounting for some impairment evaluations.110

b. Consideration of Measurement Attributes 

In developing standards, accounting standard-setters typically provide some degree of 

measurement guidance, including the required or permitted measurement attribute(s) to apply to 

the assets and liabilities that are covered by the particular standard. Ideally, the conceptual 

frameworks for the set of accounting standards would provide the standard-setter with tools to 

use in deciding when to apply particular measurement attributes. However, the Boards’ staffs 

have noted that measurement is one of the more underdeveloped areas in the accounting 

conceptual frameworks, commenting that “[n]either of the current [conceptual] frameworks 

provides any analysis of the strengths and weaknesses of the various measurement bases, nor do 

they offer any guidance on choosing among the listed bases or considering other alternatives.”111 

In a 2003 study on principles-based accounting standards, the Staff observed that an ideal 

principles-based or objectives-oriented accounting standard would, among other things, be based 

on an improved and consistently applied conceptual framework.112 The Staff also observed that 

several facets of the FASB’s existing conceptual framework would need to be addressed in order 

to facilitate a shift to a more principles-based regime, including the establishment of a paradigm 

for selecting from among possible measurement attributes.113 

Since 2004, the Boards have been engaged in ongoing work to improve, on a joint basis, their 

existing respective conceptual frameworks. The project has multiple phases, with “Phase C” 

focusing on measurement.114 Phase C of the project seeks to identify and define possible 

measurement bases (“Milestone I”), evaluate the measurement basis candidates (“Milestone II”), 

and draw conceptual conclusions (such as whether use of a single measurement basis would 

satisfy the needs of financial statement users or if some combination of bases is needed), as well 

as address practical measurement issues that the Boards encounter when developing standards 

(“Milestone III”). Milestone I was completed in Spring 2007, with the Boards agreeing to a set 

of nine proposed measurement basis candidates, which differ in terminology from the 

measurement bases described earlier that are currently in use.115 The nine proposed 

measurement basis candidates are discussed further in Section VI.B of this study. 

 

110 See IFRS 5A. 

111 See the Boards’ staffs, Conceptual Framework Project Phase C: Measurement Milestone I Summary Report – 

Inventory and Definitions of Possible Measurement Bases (“Milestone I Summary Report”). (available at: 

http://www.fasb.org/project/CF_Milestone_I_Summary_Report.pdf) 

112 See Study Pursuant to Section 108(d) of the Sarbanes-Oxley Act of 2002 on the Adoption by the United States 

Financial Reporting System of a Principles-Based Accounting System, July 2003 (“Principles-Based Accounting 

Study”), at Executive Summary. 

113 See Ibid. 

114 See information about the Boards’ joint project at: 

http://www.fasb.org/project/conceptual_framework.shtml#background.

115 See Milestone I Summary Report. 
41

The Staff has previously observed a need for the FASB’s existing conceptual framework to more 

clearly articulate how the trade-offs among relevance, reliability, and comparability of 

accounting information should be made.116 Relevance, reliability, and comparability are referred 

to as “qualitative characteristics” of accounting information, and have been described as 

follows:117

• Relevance – the capacity of information to make a difference in a decision by helping users 

to form predictions about the outcomes of the past, present, and future events or to confirm or 

correct prior expectations. 

• Reliability – the quality of information that assures that information is reasonably free from 

error and bias and faithfully represents what it purports to represent. 

• Comparability – the quality of information that enables users to identify similarities in and 

differences between two sets of economic phenomena. 

During January and February 2007, the Boards held roundtable discussions on measurement and 

gathered views from the roundtable participants as to how well different measurement bases 

satisfied these qualitative characteristics.118 The most frequent comment about historical cost as 

a measurement basis was that it is reliable. The most frequent criticism of historical cost was 

that it is not relevant. A few participants noted that historical cost is not comparable (i.e., it gives 

different numbers for the same items). 

In contrast, the most frequent comment about fair value was that it is the most relevant attribute 

for an asset or liability (i.e., contemporary information is more useful to financial statement users 

in making decisions). However, some participants expressed concerns about fair value on the 

grounds that it is not reliable. More specific comments about fair value were that it is not 

objective, it is not precise, it is subject to too many assumptions, and that investors are skeptical 

of mark-to-model numbers. 

 

116 See Principles-Based Accounting Study. 

117 See SFAC No. 2, Qualitative Characteristics of Accounting Information. 

118 Roundtable participants included representatives of reporting entities (preparers), auditors, investors, regulators, 

and other users of financial reporting. See Boards’ staffs, Summary Report of the Conceptual Framework 

Measurement Roundtables, Hong Kong, London, and Norwalk (January and February 2007), paragraph 52. 

(available at http://www.fasb.org/project/cf_roundtable_summary_report.pdf) 
42
43

II. Effects of Fair Value Accounting Standards on Financial 

Institutions’ Balance Sheets 

This section of the study examines the impact of fair value accounting on financial institutions’ 

balance sheets.119 While not mandated by the Act, to obtain a more complete understanding of 

the impact of such accounting, this section also considers its impact on the income statement. 

Specifically, this section provides: 

• An overview of the methodology for studying the effects of fair value accounting standards; 

and 

• Empirical findings from this study. 

As demonstrated by this study, fair value, on an overall basis, is used to measure less than a 

majority of assets and liabilities of financial institutions, with mark-to-market accounting (for 

which changes in fair value are recognized in income) representing a significantly smaller 

population of instruments, generally comprised of trading securities and derivatives. However, 

the impact of changes in fair value on the income statement is significant. 

A. Methodology for Studying Effects of Fair Value Accounting Standards 

For purposes of this section, the Staff studied the application of fair value accounting on 

financial institutions’ balance sheets based on a sample of 50 issuers determined as follows: 

• The Staff prepared a list of public financial institutions on a best-efforts basis. The Staff 

focused on public entities due to the readily available financial data for these entities. This 

list included banks, broker-dealers, and insurance companies, as mandated by the Act, as 

well as credit institutions and GSEs, as they are also institutions in the financial sector that 

may be affected by fair value accounting standards. Inclusion in this list was based on 

Standard Industrial Classification, or SIC, codes120 and comprised over 900 issuers. 

• The Staff ranked this population by total reported value of assets as of the issuer’s most 

recent fiscal year end. 

• The Staff selected a sample of 50 issuers from this ranked list as follows: 

o To obtain at least 75% coverage of financial institution assets in the U.S. as of the most 

recent fiscal year end, after the exclusions discussed below, the Staff chose the first 30 

issuers on this list. Throughout this section, these larger financial institutions are referred 

 

119 Unless otherwise specified, percentages and dollar amounts throughout the remainder of this study represent 

approximations. 

120 The following SIC codes were included in the sample: 6000, 6011, 6020-22, 6025, 6030, 6035-36, 6111, 6140, 

6141, 6200, 6210-11, 6231, 6282, 6305, 6310-11, 6320-21, 6324, 6330-31, 6350-51, 6360-61, 6399, 6411 6712, and 

6719. 
44

to as “large issuers.” All issuers in this sample had assets as of the most recent fiscal year 

end of greater than $135 billion. 

o To obtain a representative sample of smaller financial institutions, the Staff chose 20 

issuers, starting with the next largest company in this ranked list and then every 42nd

company. Throughout this study, these smaller financial institutions are referred to as 

“small issuers.” 

o If an initially selected company did not meet the additional criteria below, it was 

excluded and the immediately following company was selected. 

- Foreign private issuers were excluded due to the difficulty in obtaining financial 

information under U.S. GAAP on an annual and quarterly basis. 

- Issuers with year-ends other than November 30 or December 31 were excluded to 

facilitate comparability of financial results on an annual and quarterly basis.121 

- Issuers were excluded if they did not have current financial statements, notes to the 

financial statements, and MD&A disclosures available via annual filings (i.e., Forms 

10-K or 10-KSB) and quarterly filings (i.e., Forms 10-Q or 10-QSB) with the SEC. 

Data utilized for this study were obtained from Forms 10-K, 10-KSB, 10-Q, and 10-QSB, as 

applicable, filed by these issuers with the SEC. 

The effective date for SFAS No. 157 and SFAS No. 159 was January 1, 2008 for all calendar 

year-end companies. Accordingly, the Staff performed its study as of the end of the first 

reporting quarter after the effective date of SFAS No. 157 and SFAS No. 159 (first quarter 2008) 

for all companies for the purposes of the balance sheet study. However, companies were 

permitted to early adopt both standards as of January 1, 2007. Eleven issuers in the sample 

(primarily large banks and broker-dealers) early adopted these standards. Therefore, during the 

2007 calendar year, there is a lack of comparability of accounting information between early 

adopters and those that did not early adopt. Accordingly, to understand progression and changes 

in the use of fair value over time, the Staff compared financial information as of the end of 2006 

and first quarter 2008, as neither SFAS No. 157 nor SFAS No. 159 was effective for the 2006 

calendar year for any company and all companies had completed their adoption of these 

standards as of the first quarter of 2008. Where SFAS No. 157 and SFAS No. 159 had no impact 

on specific financial data, the Staff compared 2006, 2007, and 2008. 

The inclusion of third quarter information in the analysis of the impact was determined by the 

timing of the availability of third quarter information, as third quarter filings for most issuers in 

the sample selected were not due until November 10, 2008. Accordingly, third quarter 

information was primarily utilized in certain analyses to demonstrate the progressive impact of 

fair value accounting over time. As of December 15, 2008, two issuers (one large bank and one 

 

121 There were three issuers in the sample which had November 30 year-ends and 47 issuers in the sample which had 

December 31 year-ends. 
45

large broker-dealer) had not filed a Form 10-Q for the third quarter of 2008. Accordingly, to the 

extent that third quarter 2008 information is included in an analysis, prior period data are shown 

both on an actual basis and a pro forma basis, excluding the effects of these two issuers to 

facilitate comparability over time. 

The analysis of the impact of fair value was performed on the sample group of issuers as a 

whole, by issuer industry, and / or by issuer size. This study analyzed the impact of fair value 

(what is measured at fair value) as well as SFAS No. 157 (how to measure fair value) on the 

financial statements of financial institutions. 

Exhibit II.1: Size of Issuers in Sample 

Sub-Samples 

Full Sample 

(n=50)

Large Issuers 

(n=30)

Small Issuers 

(n=20)

U.S. Market (U.S. $ in millions)

Capitalization of 

Common Stock a $1,213,174 $1,202,653 $10,521 

Total Assets b $17,668,996 $17,589,482 $79,484 

Total Liabilities b $16,413,693 $16,345,671 $68,022 a

Market capitalization as of July 31, 2008 is equal to the number of shares outstanding multiplied by the closing stock price as

of July 31, 2008. The corresponding values were obtained from the daily files of the Center for Research in Securities Prices at 

the University of Chicago - Graduate School of Business. 

b

These data were collected from the face of the balance sheet in the Form 10-K or 10-KSB filing for the fiscal year ended 2007. 

Exhibit II.2: Industry Grouping of Issuers in Samplea

Sub-Samples 

Full Sample 

(n=50)

Large Issuers 

(n=30)

Small Issuers 

(n=20)

Banking 27 13 14 

Insurance 12 8 4 

Broker-Dealer 5 4 1 

Government Sponsored Enterprises 3 3 0 

Credit Institutions 3 2 1 

a 

These data were collected based on SIC code from the cover page of each issuer’s Form 10-K or 10-KSB filing. 

B. Empirical Findings from this Study on Effects of Fair Value Accounting 

Standards

This section discusses the empirical findings from the study of issuer filings to determine the 

impact of fair value on financial statements of financial institutions. These findings are 

organized into subsections on assets, liabilities, equity, and income statements. Within these 

subsections, the Staff analyzed the effects of fair value accounting for all financial institutions in 
46

the sample and, as appropriate, by issuer industry and issuer size to more fully explore findings 

noted on an overall basis. 

1. Assets 

a. Significance of Assets Measured at Fair Value 

i. Percentage of Assets Measured at Fair Value 

Analysis on Overall Basis

Exhibit II.3 illustrates that, overall, financial institutions recorded 45% of all assets at fair value 

as of first quarter-end 2008. This percentage only includes assets that are measured at fair value 

on a recurring basis in the balance sheet (either by requirement or election).122 

Exhibit II.3: Percentage of Assets Measured at Fair Value – As of First Quarter-End 2008

45%

55%

Fair Value

Other than

Fair Value

Analysis by Issuer Industry

Exhibit II.4 illustrates the percentage of assets measured at fair value by issuer industry as of first 

quarter-end 2008. 

 

122 See explanation of differences between recurring and non-recurring fair value measurements in Section I.D.2 of 

this study. 
47

Exhibit II.4: Percentage of Assets Measured at Fair Value by Industry – As of First Quarter-End 

2008 

50% 56%

71%

14%

31%

0%

20%

40%

60%

80%

100%

Banking BrokerDealersCredit

Institutions

GSEs Insurance

Industry

Percentage

Banking 

Thirty-one percent of bank assets were reported at fair value as of first quarter-end 2008. Banks 

generally carried investment securities, trading assets, and derivatives at fair value. For the 

banks in the sample, these items represented 12%, 13%, and 4%, respectively, of total assets. 

Broker-Dealers 

Fifty percent of broker-dealer assets were reported at fair value as of first quarter-end 2008. This 

industry reported large trading and derivative instruments portfolios (including inventory), which 

were measured at fair value. Specifically, these assets constituted 43% of broker-dealer total 

assets, and 87% of assets that were measured at fair value. However, cash, fixed assets, accounts 

receivable, securities borrowed, and reverse repurchase agreements were reported at historical 

cost or at contract or collateral values, which comprised the remaining 50% of the balance sheet 

unless the FVO is selected for eligible instruments. Given the nature of the assets not recorded at 

fair value, it is possible that many of these asset classes were recorded at amounts near fair value, 

as cost is likely to approximate fair value (e.g., cash, short-term receivables, and reverse 

repurchase agreements). 

Credit Institutions 

As of first quarter-end 2008, 14% of credit institution assets were reported at fair value. The 

majority of credit institution assets consisted of cash and cash equivalents, loans, and accounts 

receivable, which were generally not reported at fair value. Investment securities were the major 

category of assets reported at fair value and accounted for 92% of all assets reported at fair value. 

Overall, investment securities constituted 13% of total assets for credit institutions. 

GSEs 

Exhibit II.4 illustrates that 56% of the total assets of GSEs were reported at fair value as of first 

quarter-end 2008. GSEs had investment securities and trading accounts that were reported at fair 
48

value. For the GSEs in the sample, these items represent 49% and 6%, respectively, of total 

assets. Investment securities were the major category of assets reported at fair value and 

accounted for 87% of all assets reported at fair value. 

Insurance 

Exhibit II.4 illustrates that at 71% of total assets, the insurance industry had the greatest amount 

of assets reported at fair value on the balance sheet as of first quarter-end 2008. Insurance 

companies reported investment securities and separate account assets at fair value. For the 

insurance companies in the sample, these items represented 44% and 24%, respectively, of total 

assets. These two asset categories accounted for 96% of all assets at fair value.

Analysis by Issuer Size

Exhibit II.5 shows the level of fair value measurements as a percentage of total assets of the large 

issuers compared to the small issuers as of first quarter-end 2008. 

Exhibit II.5: Percentage of Assets Measured at Fair Value by Issuer Size – As of First Quarter-End 

2008 

45%

55% 54%

46%

0%

20%

40%

60%

80%

100%

Large Issuers Small Issuers

Size

Percentage

Fair Value

Other than Fair Value

As of first quarter-end 2008, the analysis illustrates that the percentage of assets measured at fair 

value was 45% for the large issuers and 54% for the small issuers. The small issuers included in 

the sample have a larger percentage of assets at fair value than the large issuers due to the 

industry composition of the large and small issuer groups. As noted above, insurance companies 

comprised about 18% of large issuer total assets, and approximately 72% of small issuer total 

assets. Insurance companies generally reported a greater percentage of assets at fair value. 

Further, insurance companies in the small issuer group reported 69% of total assets are at fair 

value, which was only slightly lower than the 71% of assets at fair value for the large insurance 

companies. 

With respect to the non-insurance companies in the large issuer group, 39% of their assets were 

recorded at fair value compared to only 16% of assets at fair value for the non-insurance 

companies in the small issuers sampled. There were two primary reasons the percentage of 
49

assets at fair value for the large non-insurance issuers exceeded that of the small non-insurance 

issuers. First, large issuers had higher levels of investments in trading and derivative assets that 

were required to be reported at fair value. For both large and small non-insurance companies, 

the majority of assets at fair value were investments, trading assets, and derivatives; however, 

these accounts represented 36% of total assets for large issuers and only 14% of total assets for 

small issuers. The second reason related to management elections to report certain assets at fair 

value on a voluntary basis. In the sample of non-insurance issuers, 17 large issuers made the 

election to use fair value to measure assets compared to one issuer in the group of small issuers. 

 

ii. Percentage of Assets Measured at Fair Value through 

Income 

Overall Analysis

Although 45% of assets of the sampled issuers were measured at fair value on an overall basis as 

of first quarter-end 2008, as noted in Section I.B, the change in the fair value of assets measured 

at fair value on a recurring basis did not always impact income, as some changes in asset fair 

values were recognized in OCI or were offset by equivalent changes in related liabilities. 

Specifically, Exhibit II.6 illustrates that 25% of total assets were measured at fair value through 

the income statement.123 The remaining 20% were measured at fair value, but did not affect 

income. 

Exhibit II.6: Percentage of Assets whose Changes in Fair Value Affected Income compared with 

Percentage of Assets whose Changes in Fair Value Did Not Affect Income and Percentage of Assets 

Not Reported at Fair Value – As of First Quarter-End 2008 

20%

25%

55%

Fair Value Not Affecting

Income

Fair Value Affecting

Income

Other than Fair Value

 

123 As a result of the unique nature of derivatives that qualify for netting under ISDA master netting arrangements, 

the Staff was unable to specifically identify the fair value of derivatives that were in asset positions and designated 

in cash flow hedging relationships. The Staff, therefore, considered all derivative instruments as impacting the 

income statement. 
50

Analysis by Issuer Industry

Exhibit II.7 provides an analysis of assets measured at fair value through the income statement, 

assets measured at fair value without affecting income, and assets that were measured at other 

than fair value by issuer industry. 

Exhibit II.7: Percentage of Assets whose Changes in Fair Value Affected Income compared with 

Percentage of Assets whose Changes in Fair Value Did Not Affect Income and Percentage of Assets 

Not Reported at Fair Value by Industry – As of First Quarter-End 2008 

0%

20%

40%

60%

80%

100%

Fair Value

Not Affecting

Income

Fair Value

Affecting

Income

Other than

Fair Value

Percentage

Banking

Broker-Dealers

Credit Institutions

GSEs

Insurance

Banking 

Exhibit II.4 illustrates that 31% of total bank assets were reported at fair value as of first quarterend 2008. Of assets reported at fair value, 30% constituted investment securities reported as 

AFS (with changes in fair value recognized in OCI). Accordingly, as illustrated in Exhibit II.7, 

22% of total assets were reported at fair value with changes in value impacting income, primarily 

comprised of trading securities and derivatives, and 9% of total assets were reported at fair value 

changes recognized in OCI. 

Broker-Dealers 

Exhibit II.4 illustrates that 50% of broker-dealer assets were measured at fair value and changes 

in the fair value of almost all of these assets were reported in the income statement. Brokerdealers generally had an insignificant percentage of assets that were measured at fair value 

through OCI. This industry reported large trading and derivative instruments portfolios 

(including trading inventory), which were measured at fair value with changes recorded in the 

income statement. 

Credit Institutions 

Of the 14% of total credit institution assets measured at fair value as of first quarter-end 2008, 

90% of assets measured at fair value were investment securities classified as AFS. Thus, the 

issuers sampled in this industry group had 1% of total assets measured at fair value with changes 
51

in fair value recorded in the income statement, and 13% of total assets measured at fair value 

with changes recorded in OCI. 

GSEs 

Of the 56% of total assets measured at fair value as of first quarter-end 2008, 76% were 

investment securities classified as AFS. Therefore, this industry group had 13% of assets that 

were measured at fair value with changes in fair value recorded in the income statement and 43% 

of assets measured at fair value with change recorded in OCI. 

Insurance 

Exhibit II.4 illustrates that at 71% of total assets as of first quarter-end 2008, the insurance 

industry had the greatest amount of assets reported at fair value on the balance sheet. However, 

62% of total insurance company assets that were reported at fair value did not affect net income. 

Specifically, 38% of their total assets were AFS investment securities which were measured at 

fair value, with the changes in the fair value of such assets recorded in OCI. The next largest 

group of assets recorded at fair value was separate account assets, which represented 24% of 

total assets. These separate account assets had an offsetting separate accounts liability, and the 

change in the fair value of the separate account assets generally resulted in an equal and 

offsetting change in the separate account liability. Therefore, although this item was recorded at 

fair value, the net change in fair value of the asset and liability had little, if any, impact on net 

income on a recurring basis. In other words, the changes in fair value offset. After considering 

investment securities and separate account assets, 9% of total assets measured at fair value 

impacted the income statement for the insurance industry. 

Analysis by Issuer Size

Exhibit II.8 provides an analysis of assets measured at fair value through the income statement, 

assets measured at fair value without affecting income, and assets that were measured at other 

than fair value by issuer size as of first quarter-end 2008. 
52

Exhibit II.8: Percentage of Assets whose Changes in Fair Value Affected Income compared with 

Percentage of Assets whose Changes in Fair Value Did Not Affect Income and Percentage of Assets 

Not Measured at Fair Value by Issuer Size – As of First Quarter-End 2008 

20% 25%

54% 55%

46%

0%

20%

40%

60%

80%

100%

Fair Value Not

Affecting

Income

Fair Value

Affecting

Income

Other than Fair

Value

Percentage

Large Issuers

Small Issuers

Large issuers sampled included a greater proportion of broker-dealers and banks that reported a 

larger percentage of trading assets and derivative portfolios which were required to be measured 

at fair value with changes in fair value recorded in income. The small issuer group was 

comprised of banks and insurance companies that had larger fixed-income securities portfolios 

that were generally designated as AFS. 

iii. Distribution of Issuers by Percentage of Assets 

Measured at Fair Value 

Overall Analysis

Although, on average, 45% of assets were measured at fair value as of first quarter-end 2008, 

issuers in the sample were not evenly distributed around this mean. Exhibit II.9 illustrates the 

number of issuers based on tiers ranging from those that used fair value to measure less than 

10% of assets to those that used fair value to measure more than 75% of their assets. A majority 

of the issuers, 36 out of 50, held 50% or less of their assets at fair value. The remaining 14 

issuers were split evenly, with seven holding between 50% and 75% of their assets at fair value 

and seven holding more than 75% of their assets at fair value. 
53

Exhibit II.9: Distribution of Issuers by Percentage of Assets Measured at Fair Value – As of First 

Quarter-End 2008 

2% 6%

34% 30%

14% 14%

0%

20%

40%

60%

80%

100%

0% 0% < X ≤

10%

10% < X ≤

25%

25% < X ≤

50%

50% < X ≤

75%

> 75%

Percentage of Assets at Fair Value

Percentage of Sample

Of the seven issuers with fair value assets representing 50% to 75% of total assets, one was a 

bank, two were broker-dealers, and four were insurance companies. Of the seven issuers with 

fair value assets representing greater than 75% of total assets, one was a GSE and six were 

insurance companies. See additional discussion related to the distribution in the analysis 

performed by industry after Exhibit II.10. 

Analysis by Issuer Industry

Similar to the overall analysis, the distribution on an industry basis as of first quarter-end 2008 

shows that issuers’ percentages of assets at fair value were not evenly distributed around the 

mean. 

Exhibit II.10: Distribution of Issuers by Percentage of Assets Measured at Fair Value by Industry – 

As of First Quarter-End 2008

0%

20%

40%

60%

80%

100%

0% 0% <

X ≤

10%

10% <

X ≤

25%

25% <

X ≤

50%

50% <

X ≤

75%

> 75%

Percentage of Assets at Fair Value

Percentage

Banking

Broker-Dealers

Credit Institutions

GSEs

Insurance

Banking 

In the banking industry, one bank had assets reported at fair value in an amount greater than 50% 

of total assets. On average, 22% of total assets at banks sampled were reported at fair value, 
54

with changes in fair value reported in the income statement. Fifteen banks in the sample ranged 

from 10% to 25% (mainly around the upper end of this range) and nine banks ranged from 25% 

to 50% (mainly around the lower end of this range). The banking industry reported total assets 

measured at fair value ranging from 5% to 51%. 

Broker-Dealers 

In the broker-dealer industry, two broker-dealers reported assets at fair value of greater than 50% 

of total assets and three reported assets at fair value between 25% and 50% of total assets. The 

broker-dealer industry reported total assets measured at fair value ranging from 39% to 65%. 

Credit Institutions 

Credit institutions tended to be on the lower end of the distribution range. One credit institution 

reported no assets measured at fair value and the other two reported assets measured at fair value 

ranging between 10% and 25% of total assets. The credit institutions had total assets measured 

at fair value which range from 0% to 16%. 

GSEs 

Of the three GSEs sampled, there was one GSE each in the ranges of 0% to 10%, 25% to 50%, 

and greater than 75% of total assets measured at fair value. This primarily occurred as one GSE 

held a large portfolio of loans which are accounted for on a historical cost basis, another GSE 

held a large portfolio of securities which are backed by similar loans but are accounted for at fair 

value, and the third GSE had a mixed portfolio of loans and securities. GSEs had 6%, 40%, and 

82% of total assets at fair value. 

Insurance 

Exhibit II.10 illustrates that fair value measurements were used more extensively by the 

insurance companies – 10 of the 12 companies had greater than 50% of total reported assets 

measured at fair value. Insurance companies tended to be on the higher end of the range 

primarily because they carried relatively large portfolios of AFS securities and separate accounts. 

Insurance companies had total assets measured at fair value ranging from 26% to 85%. 

iv. Use of Fair Value Option 

Several recent FASB standards (SFAS No. 155, 156 and 159) provided companies with an 

option to measure certain assets at fair value. While the effective dates of these statements were 

different, for the purposes of this study, the following tables demonstrate the percentage of assets 

that were reported at fair value as a result of a voluntary election made by the issuer as of first 

quarter-end 2008. For five issuers (one bank, two broker-dealers, one GSE, and one insurance 

company), the FVO was elected to measure certain assets, but the Staff could not separately 

determine the impact of such elections because their disclosures did not provide sufficient 

disaggregation to separately identify the assets. For one bank, the Staff was unable to determine 

whether the FVO was elected. These six issuers have been excluded from the analysis below.
55

Analysis on Overall Basis

The elective use of fair value under the FVO was not made extensively by issuers in the sample. 

As illustrated in Exhibit II.11 below, 4% of total assets were reported at fair value by using fair 

value accounting on a voluntary basis as of first quarter-end 2008. This may explain the slight 

increase in fair value from year-end 2006 to first quarter-end 2008 noted in Exhibit II.13 below. 

Exhibit II.11: Percentage of Assets Reported under the FVO – As of First Quarter-End 2008 

4%

96%

Fair Value Option

Assets

All Other Assets

The fair value election was primarily selected for certain HFS loans, which issuers manage on a 

fair value basis and for other assets such as MSRs where hedge accounting provisions are 

complex making FVO an attractive choice. Additionally, several issuers elected the FVO for 

reverse repurchase agreements. 

Analysis by Issuer Industry

As illustrated in Exhibit II.12 below, the percentage of FVO assets to total assets, by industry, 

was 4% for banks, 6% for broker-dealers, 5% for GSEs, and 3% for insurance companies. 
56

Exhibit II.12: Percentage of Assets Reported under the FVO by Industry – As of First Quarter-End 

2008 

4% 6% 0% 5% 3%

0%

20%

40%

60%

80%

100%

Banking BrokerDealersCredit

Institutions

GSEs Insurance

Industry

Percentage

Banking 

While 31% of total bank assets were recorded at fair value as of first quarter-end 2008 (see 

Exhibit II.4), 4% were those in which the bank voluntarily elected to measure the asset at fair 

value under the FVO. In the sample of 27 banks, 14 did not select the FVO for any assets. For 

11 banks,124 the percentage of assets for which the FVO was selected to total assets ranged from 

0.1% to 7% of total assets.125 Asset classes for which the large issuers selected the FVO 

included loans (64%), reverse repurchase agreements (21%), other assets (6%), investments 

(5%), HFS loans (3%), HFS mortgage loans (1%), and an immaterial amount of trading assets 

and MSRs. One bank in the small issuer sample elected to record one asset, HFS loans, at fair 

value under the FVO, which represented 2% of that issuer’s total assets held at fair value at 

March 31, 2008. The use of FVO was most prevalent in the large issuer group, with assets 

voluntarily recorded at fair value for 4% of total assets for this group. 

Broker-Dealers 

While broker-dealers recorded half of their assets, or 50%, at fair value, 6% were those where 

the issuer voluntarily elected to measure the assets at fair value under the FVO. In the sample of 

four large issuer broker-dealers, one issuer did not elect the FVO for any assets. Three issuers 

elected to use the FVO, but two of these issuers did not provide disclosures to sufficiently 

segregate the assets reported at fair value pursuant to the FVO from other assets reported at fair 

value. There was one broker-dealer in the sample of small issuers, and this issuer did not elect to 

measure any assets at fair value. For the one broker-dealer that utilized the FVO election and 

where disclosures were sufficient to determine the separate impact, the percentage of total assets 

for which the FVO was selected was 10%. Assets for which the FVO was selected included 

reverse repurchase agreements (94%), investments (5%), and loans (1%). 

 

124 As noted above, the Staff was unable to determine whether the FVO was selected for one bank. 

125 As noted above, one bank was not analyzed due to a lack of information. 
57

Credit Institutions

None of the three credit institutions elected to measure assets at fair value under the FVO. 

GSEs 

While 56% of total GSE assets were recorded at fair value, 5% were those related to a voluntary 

election to measure assets at fair value under the FVO. All three of the GSEs in the sample 

elected the FVO. However, as mentioned above, one GSE did not provide disclosures to 

sufficiently segregate the assets reported at fair value pursuant to the FVO from other assets 

reported at fair value. For the two GSEs that did use the FVO election and for which disclosure 

was sufficient to segregate the impact, the analysis illustrated that assets for which the FVO was 

selected constituted 6% and 2%, respectively. Assets for which the FVO was selected included 

both non-mortgage-related securities and mortgage-related securities. 

Insurance 

Four of the 12 insurance companies made a FVO election, which involved insignificant assets 

and liabilities in comparison to the respective consolidated amounts. The FVO was elected for 

short-term investments; trading securities (previously classified as AFS); securities purchased 

under agreements to resell; fixed-maturity and equity securities backing certain pension 

products; commercial loans; private equity investments; and investments in loan funds, hedge 

funds, non-U.S. fixed-income funds, and catastrophe bonds. 

v. Comparison of Percentage of Assets Measured at Fair 

Value Before and After Adoption of SFAS No. 157 and 

SFAS No. 159 

To isolate the impact of SFAS No. 157 and SFAS No. 159 on the amount of assets measured at 

fair value, the Staff compared the use of fair value before and after the effective date of these 

standards. Towards this end, the percentage of assets at fair value before the adoption of SFAS 

No. 157 (as of year-end 2006) was compared with the percentage of assets at fair value upon the 

adoption of SFAS No. 157 (as of first quarter-end 2008). Further, as illustrated in Exhibit II.11, 

the voluntary FVO election appears to explain the slight increase. 

Analysis on Overall Basis

The results of this analysis illustrate that the adoption of SFAS No. 157 and SFAS No. 159 did 

not have a significant impact on the percentage of assets that were measured at fair value, which 

changed from 42% as of year-end 2006 to 45% as of first quarter-end 2008. 
58

Exhibit II.13: Percentage of Assets Measured at Fair Value over Time 

42% 45%

0%

20%

40%

60%

80%

100%

2006 Q1 2008

Period End

Percentage

Analysis by Issuer Industry

As illustrated in Exhibit II.14, other than broker-dealers and GSEs, the percentage of assets at 

fair value was fairly consistent by issuer industry over time. The increase in the percentage of 

assets at fair value for broker-dealers appears to, in part, be explained by the FVO discussed 

above, which accounted for 6% of additional assets at fair value. The decline in the percentage 

of assets at fair value for the GSEs occurred, in part, due to voluntary growth limits on retained 

portfolios and sales of AFS securities, decreasing the size of investment securities carried at fair 

value. 

Exhibit II.14: Percentage of Assets Measured at Fair Value over Time by Industry 

27%

39%

12%

62%

71%

31%

50% 56%

 14%

 71%

0%

20%

40%

60%

80%

100%

Banking BrokerDealersCredit

Institutions

GSEs Insurance

Industry

Percentage

2006

Q1 2008

b. Nature of Assets Measured at Fair Value on a Recurring Basis 

Exhibit II.15 below provides detail of the various types of assets that are measured at fair value 

on a recurring basis. Investment securities represented the largest percentage of such assets at 

44%, of which 85% are AFS securities with changes in fair value recognized in OCI and 15% are 
59

reported at fair value through income. Therefore, at 32% of the total population of assets 

measured at fair value, trading instruments is the largest category that impacts the income 

statement, followed by derivatives at 9%. Separate accounts, which comprised 9% of the total 

assets at fair value, did not impact the income statement as changes in the fair value of separate 

account assets were offset by corresponding changes in the separate account liabilities. 

Accounting for the various types of assets is discussed in detail in Section I.D. A brief 

discussion of the types of instruments that are included in these asset classes follows. 

Investments

Investments generally include investments in debt or equity securities. Debt securities generally 

include investments in fixed-income securities, agency and non-agency mortgage-backed 

securities, and other asset-backed securities. Some of these securities are reported at fair value, 

while others are reported at cost (e.g., equity securities without readily determinable fair values). 

Trading Accounts

Trading accounts consist of instruments that financial institutions are holding for trading 

purposes, including derivatives; debt and equity trading instruments, including fixed-income 

securities and government and corporate debt; equity, including convertible securities; loans; and 

physical commodities inventories. The revenue derived from trading accounts is primarily based 

on the changes in the fair value of the portfolio. 

Separate Accounts

Separate account assets are reported at fair value and are generally established by insurance 

companies to make certain investments on behalf of contract holders. These assets may be used 

to fund retirement plan contracts or group pension contracts. While these contract holders retain 

the risk of the investment and receive some or all of the investment returns, the assets in these 

accounts are legally owned by the insurance company. A separate account liability is recorded 

representing amounts payable to contractholders. As such, investment performance, including 

realized capital gains and losses, and changes in unrealized gains and losses are generally fully 

offset within the statement of operations. 

Derivatives 

Derivative instruments enable users of such investments to increase, reduce, or alter exposure to 

interest, credit, or other market risks. The value of a derivative is derived from its reference to 

an underlying variable or combination of variables, such as interest rate indices, equity prices, 

foreign exchange rates, credit, and commodity prices. Issuers in the sample could be both 

dealers and users of derivatives. Companies often use derivatives in order to hedge market 

exposures, modify the interest rate characteristics of related balance sheet instruments or meet 

longer-term investment objectives. 
60

Exhibit II.15: Nature of Assets Measured at Fair Value – As of First Quarter-End 2008 

44%

32%

9%

9%

6%

Investments

Trading Accounts

Separate Accounts

Derivatives

Other*

* Includes reverse repurchase agreements, loans, other assets, and MSRs. 

c. Classification of Assets in Fair Value Hierarchy 

One objective of SFAS No. 157 is to improve the consistency and comparability of fair value 

measurements. Accordingly, SFAS No. 157 requires a tabular disclosure for all items measured 

at fair value on a recurring basis. Specifically, as discussed in Section I.D, the FASB created a 

fair value hierarchy and required that all items measured at fair value be classified in this 

hierarchy based on the nature of the inputs used to develop the measurement. 

A significant concern expressed in applying a fair value measurement standard is the challenge 

that companies face in valuing instruments when markets are not active. As illustrated by 

Exhibit II.16, of all assets that were reported at fair value, a majority (76%) of the assets were 

Level 2 instruments for which inputs were observable, followed by Level 1 instruments (15%) 

which had quoted prices, and Level 3 instruments (9%) where significant market information is 

not observable. 

Exhibit II.16: Fair Value Hierarchy Classification of Assets Measured at Fair Value – As of First 

Quarter-End 2008 

15%

76%

9%

Level 1

Level 2

Level 3
61

 i. Fair Value Hierarchy Classification over Time 

Analysis on Overall Basis

To determine the impact of the change in economic conditions, especially the increasing lack of 

liquidity in the marketplace, the change in the classification of assets measured at fair value was 

analyzed from first quarter-end 2008 to third quarter-end 2008. See Exhibit II.17 for this 

analysis. Overall, this analysis illustrated the classification within each of the levels remained 

fairly consistent from first quarter-end 2008 to third quarter-end 2008, with a 1% decline in the 

percentage of assets in Level 1 and a 1% increase in Level 3. 

Exhibit II.17: Fair Value Hierarchy Classification of Assets Measured at Fair Value over Time 

15%

76%

9% 15%

76%

9% 14%

76%

10%

0%

20%

40%

60%

80%

100%

Level 1 Level 2 Level 3

Classification

Percentage

Q1 2008

Q1 2008 excluding Q3 NonFilers

Q3 YTD 2008

Analysis by Issuer Industry

Exhibit II.18 provides an analysis of the fair value hierarchy classification of assets reported at 

fair value by issuer industry. The insurance industry had the lowest Level 2 and the highest 

Level 1 composition, credit institutions had the highest Level 2 and lowest Level 3 composition, 

and GSEs had the highest Level 3 and the lowest Level 1 composition. 
62

Exhibit II.18: Fair Value Hierarchy Classification of Assets Measured at Fair Value by Industry – 

As of First Quarter-End 2008 

11% 17%

3% 0%

30%

82%

73%

90%

80%

63%

7% 10% 6%

20%

7%

0%

20%

40%

60%

80%

100%

Banking BrokerDealersCredit

Institutions

GSEs Insurance

Industry

Percentage

Level 1

Level 2

Level 3

Banking 

For banks, 82% of assets measured at fair value were measured using Level 2 inputs, followed 

by 11% using Level 1, and 7% using Level 3. It appears that for many Level 2 assets, banks 

generally used an alternative pricing method that did not rely on quoted prices such as quoted 

prices for similar assets or a combination of Level 2 inputs. Level 1 was comprised of trading 

assets (59%) and investments (31%), Level 2 was comprised of derivatives (66%), investments 

(17%), and trading assets (13%), and Level 3 was comprised of trading assets (40%), derivatives 

(23%), and investments (16%). 

Broker-Dealers

Broker-dealers classified 17% of total assets at fair value as Level 1, 73% as Level 2, and 10% as 

Level 3. Eighty-seven percent of the broker-dealers’ assets at fair value were either trading 

assets or derivative assets. Level 1 was comprised of 97% trading assets, Level 2 was comprised 

of 34% trading assets and 54% derivatives, and Level 3 was comprised of 61% trading assets and 

38% derivatives. Due to the nature of derivatives, they were typically not traded in active 

markets; therefore, derivatives were primarily included within Levels 2 and 3. Trading assets 

typically included investments ranging from equity securities (which were often quoted in active 

markets) to structured products for which inputs were not observable. As broker-dealers also 

deal in customized trades that can be long-dated or have correlations that cannot be observable, 

their percentage of Level 3 assets tended to be slightly higher than industries other than GSEs. 

Credit Institutions 

Ninety percent of total assets measured at fair value were classified as Level 2. Investment 

securities constituted 96% of all Level 2 assets and included investments in state and municipal 

obligations, U.S. government and agencies obligations, mortgage and other asset-backed 

securities, corporate debt securities, and foreign government bonds and obligations. 

 
63

GSEs 

GSEs classified 80% of total assets measured at fair value as Level 2. Ninety-two percent of 

those assets were trading and AFS investments such as agency mortgage-backed securities. 

Ninety-two percent of Level 3 instruments were investments such as non-agency residential 

mortgage-backed securities backed by subprime and Alt-A loans. Similar to banks, GSEs 

utilized alternative pricing methods because of large portfolios of assets and, therefore, did not 

have significant assets reported as Level 1. 

Insurance 

The insurance industry had the highest percentage of Level 1 assets at 30% of total assets at fair 

value. These assets consisted primarily of fixed-income and equity securities that were classified 

as AFS securities. Seven percent of all assets at fair value for insurance companies were Level 3 

instruments, mainly comprised of investments such as non-agency securities, including assetbacked securities backed by subprime and Alt-A loans, separate accounts, and derivatives. 

Analysis by Issuer Size

An analysis of the composition of instruments based on large versus small issuers in Exhibit 

II.19 illustrates that small issuers had a larger percentage of instruments that were classified as 

Level 1, indicating that small issuers tended to invest in less complex assets and assets for which 

quoted market prices were more readily available. This also translated into a lower percentage of 

Level 3 assets as compared to the large issuers. 

Exhibit II.19: Fair Value Hierarchy Classification of Assets Measured at Fair Value by Issuer Size 

– As of First Quarter-End 2008 

15%

76%

9%

48% 47%

4%

0%

20%

40%

60%

80%

100%

Level 1 Level 2 Level 3

Classification

Percentage

Large Issuers

Small Issuers

ii. Distribution of Issuers by Percentage of Assets 

Classified as Level 3 

Exhibit II.20 presents the distribution of issuers based on their percentage of assets classified as 

Level 3. 
64

Exhibit II.20: Distribution of Issuers by Percentage of Assets at Level 3 – As of First Quarter-End 

2008126

25% 19%

27% 25%

4%

0%

20%

40%

60%

80%

100%

0% 0% < X ≤

1%

1% < X ≤

5%

5% < X ≤

10%

> 10%

Percentage of Assets Classified as Level 3

Percentage of Sample

Twenty-five percent of the sample had no Level 3 assets. Forty-six percent of the sample had 

Level 3 assets reported at above 0% but less than 5% of total assets. Twenty-five percent of the 

sample reported Level 3 assets between 5% and 10% of total assets. Four percent of the sample 

had Level 3 assets that exceeded 10% of total assets (one, a GSE, at 20% and the other, an 

insurance company, at 15%). Level 3 assets for these issuers primarily included non-agency 

securities backed by subprime and Alt-A mortgage loans, privately placed corporate securities, 

guarantee assets, residential mortgage-backed securities, asset-backed securities, and other 

collateralized debt obligations. Of the 12 issuers which had Level 3 assets which ranged 

between 5% and 10% of total assets, there were four broker-dealers, one GSE, five insurance 

companies, and two banks. For these issuers, such instruments included private equity and real 

estate fund investments, certain corporate loans (including certain mezzanine financing, 

leveraged loans arising from capital market transactions, and other corporate bank debt), less 

liquid corporate debt securities and other debt obligations (including high-yield corporate bonds, 

distressed debt instruments, and collateralized debt obligations backed by corporate obligations), 

less liquid mortgage whole loans and securities (backed by either commercial or residential real 

estate), acquired portfolios of distressed loans, certain municipal bonds, guarantee assets, certain 

loan commitments, and certain over-the-counter derivatives such as long-dated or complex 

derivatives that trade in less liquid markets with limited pricing information. 

 

126 One issuer did not have sufficient information for this analysis and another did not have any assets at fair value. 

Both issuers were excluded from this analysis. 
65

2. Liabilities 

a. Significance of Liabilities Measured at Fair Value 

i. Percentage of Liabilities Measured at Fair Value 

Analysis on Overall Basis

As illustrated in Exhibit II.21, 15% of total liabilities were reported at fair value (either by 

requirement or election) for all the financial institutions selected as of the end of the first 

reporting quarter after the effective date of SFAS No. 157. Overall, there was a smaller 

percentage of liabilities measured at fair value compared to assets. Generally, only trading 

liabilities (at broker-dealers) and derivative liabilities were required to be reported at fair value 

(certain other liabilities may be reported at fair value on an elective basis). These two types of 

liabilities constituted 53% of all liabilities at fair value. 

Generally, changes in the fair value of liabilities are recognized in income. The only changes in 

liability fair value that would be recognized in OCI relate to derivative liabilities that are 

accounted for as cash flow hedges, which typically are an insignificant portion of a financial 

institution’s balance sheet. 

 

Exhibit II.21: Percentage of Liabilities Measured at Fair Value – As of First Quarter-End 2008 

15%

85%

Fair Value

Other than Fair Value

Analysis by Issuer Industry

Exhibit II.22 below presents the percentage of liabilities at fair value by industry as of first 

quarter-end 2008. 
66

Exhibit II.22: Percentage of Liabilities Measured at Fair Value by Industry – As of First QuarterEnd 2008 

35%

1% 2% 5%

11%

0%

20%

40%

60%

80%

100%

Banking BrokerDealersCredit

Institutions

GSEs Insurance

Industry

Percentage

Banking 

The banking industry reported the second highest percentage of liabilities at fair value at 11% as 

of first quarter-end 2008. Of this 11%, 58% constituted derivative and trading liabilities which 

were required to be reported at fair value. The remaining 42% were reported at fair value 

primarily as a result of the FVO election. Two banks accounted for 80% of all bank liabilities 

reported at fair value primarily as a result of their use of the FVO. These two banks and the four 

broker-dealers discussed below accounted for 86% of all liabilities reported at fair value as a 

result of the FVO. 

Broker-Dealers 

Exhibit II.22 illustrates that the broker-dealer industry had the greatest percentage of liabilities 

reported at fair value. Specifically, 35% of their total liabilities were measured at fair value as of 

first quarter-end 2008. The four broker-dealers included in the sample accounted for 56% of all 

trading and derivative liabilities. Trading and derivative liabilities also accounted for 52% of the 

total liabilities this industry measured at fair value. 

Additionally, as discussed above, at 50% of total assets, broker-dealers have the greatest 

percentage of assets that were measured at fair value with the changes in fair value recorded in 

the income statement. Therefore, to align the measurement basis between assets and liabilities, 

this industry had made more extensive use of the option to fair value liabilities such as 

repurchase agreements and structured notes. It appears that complex financial instruments such 

as structured notes were also more prevalently issued either by broker-dealers or large banks. 

Accounting rules surrounding such instruments are complex and in some instances involve 

extensive analysis and bifurcation of embedded derivatives and, therefore, this industry appears 

to utilize the FVO. 

This industry made the most extensive use of the FVO to fair value liabilities which primarily 

accounted for the remaining half of their liabilities at fair value. 
67

Credit Institutions 

Credit institutions had insignificant amounts of liabilities measured at fair value. 

GSEs 

GSEs had insignificant amounts of liabilities measured at fair value. 

Insurance 

Liabilities measured at fair value represented 5% of total liabilities for the insurance industry and 

consisted primarily of free-standing and embedded derivatives (38% of total liabilities at fair 

value) and long term debt (45% of total liabilities at fair value). The embedded derivatives 

related to guaranteed interest and similar insurance contracts. The derivatives and long-term 

borrowings of one large issuer represented 85% of total liabilities at fair value for the twelve 

issuers. 

Analysis by Issuer Size

As illustrated in Exhibit II.23, as of first quarter-end 2008, 15% of total liabilities were at fair 

value for the large issuers, compared to 0.1% of the liabilities for the small issuers. 

Exhibit II.23: Percentage of Liabilities Measured at Fair Value by Issuer Size – As of First QuarterEnd 2008 

15%

0%

85%

100%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Large Issuers Small Issuers

Size

Percentage

Fair Value

Other than Fair Value

Of the total liabilities reported at fair value, nearly all of these liabilities were associated with the 

large issuer sample. The analysis indicates that six of the small issuers reported liabilities 

recorded at fair value, compared to all 30 of the large issuers. Fourteen small issuers did not 

report any liabilities at fair value. Excluding these 14 issuers, the six small issuers recorded 

0.2% of their total liabilities at fair value, which is still significantly less than the 15% amount at 

fair value for the large issuers. Of these six issuers, five had derivative liabilities recorded at fair 

value and one issuer had certain other liabilities recorded at fair value. The large issuers had 

various types of liabilities recorded at fair value, including deposits, trading liabilities, 
68

derivatives, debt, repurchase agreements, and other liabilities. Certain of these liabilities, such as 

derivative liabilities, were required to be at fair value, while others, such as repurchase 

agreements, were at fair value due to the FVO election. Only one of the small issuers, an 

insurance company, selected the FVO for certain liabilities. However, 14 of the large issuers 

selected the FVO for certain liabilities. 

ii. Distribution of Issuers by Percentage of Liabilities 

Measured at Fair Value 

Although, on average, 15% of liabilities were measured at fair value, the issuers in the sample 

were not evenly distributed around this mean. Exhibit II.24 illustrates the percentage of issuers 

reporting liabilities at fair value based on graduated tiers. A majority of the issuers, or 39 out of 

50 (78%), held 5% or less of their liabilities at fair value. 

Exhibit II.24: Distribution of Issuers by Percentage of Liabilities at Fair Value – As of First 

Quarter-End 2008 

30%

48%

8% 4% 10%

0%

0%

20%

40%

60%

80%

100%

0% 0% < X ≤

5%

5% < X ≤

10%

10% < X ≤

20%

20% < X ≤

50%

> 50%

Percentage of Liabilities at Fair Value

Percentage of Sample

Analysis by Industry

As depicted in Exhibit II.25, of the 15 issuers that did not have any liabilities at fair value, 13 

were banks, one was a broker-dealer, and one was a GSE. The banks and broker-dealer were all 

small issuers. Thirty issuers reported liabilities at fair value of greater than 0% but less than 

20%, of which 13 were banks, three were credit institutions, two were GSEs, and 12 were 

insurance companies. These issuers had minimal items required to be recorded at fair value, 

such as trading liabilities and derivatives, and made minimal use of the FVO election. Five 

issuers reported liabilities of greater than 20%, but less than 50% (one bank and four brokerdealers). 
69

Exhibit II.25: Distribution of Issuers by Percentage of Liabilities Measured at Fair Value by 

Industry – As of First Quarter-End 2008 

0%

20%

40%

60%

80%

100%

0% 0% < X

≤ 5%

5% < X

≤ 10%

10% <

X ≤

20%

20% <

X ≤

50%

> 50%

Percentage of Liabilities at Fair Value

Percentage

Banking

Broker-Dealers

Credit Institutions

GSEs

Insurance

Banking

Two banks in the sample had liabilities in excess of 15% measured at fair value. Within this 

industry, the greatest percentage of liabilities measured at fair value was 23%. Most other banks 

had total liabilities measured at fair value of 5% or less. The bank that fell within the 20% to 

50% category reported liabilities fair value similar to those of the broker-dealers; specifically, 

they reported trading liabilities (4%), derivatives (6%), repurchase agreements (9%), and debt 

(4%) at fair value. 

Broker-Dealers 

Of the five issuers with the largest percentage of liabilities at fair value, four were broker-dealers 

and one was a bank. Broker-dealers in the sample had a large percentage of total liabilities that 

were required to be at fair value, such as trading liabilities (10%) and derivatives (8%), and made 

use of the FVO election for certain liabilities such as repurchase agreements (6%) and debt 

(6%). 

Credit Institutions 

All credit institutions in the sample had less than 5% of their liabilities measured at fair value. 

GSEs 

All GSEs in the sample had less than 5% of their liabilities measured at fair value. 

Insurance 

Of the 12 insurance companies in the sample, 10 insurance companies had less than 1% of 

liabilities measured at fair value, one insurance company had 6% of liabilities measured at fair 

value, and the other had 12% of liabilities measured at fair value. 
70

iii. Use of Fair Value Option 

Overall Analysis

The increase in total liabilities reported at fair value as illustrated in Exhibit II.28 appears to 

result primarily from the use of the FVO, as illustrated in Exhibit II.26, which illustrates that 5% 

of total liabilities in the sample are reported at fair value under FVO. The data below excludes 

three issuers (two broker-dealers and one insurance company) that elected liabilities under the 

FVO, but did not provide sufficient detail to be included in the analysis. 

Exhibit II.26: Percentage of Liabilities Reported under the FVO – As of First Quarter-End 2008 

5%

95%

Fair Value Option

Liabilities

All Other Liabilities

Analysis by Issuer Industry

To focus on the impact of the FVO on the change in the percentage of liabilities at fair value 

from year-end 2006 to first quarter-end 2008 by industry, the Staff performed an analysis, as 

illustrated in Exhibit II.27. Excluding broker-dealers, the use of the FVO was fairly consistent in 

the different industry groupings. As illustrated in Exhibit II.27 below, the percentage of FVO 

liabilities to total liabilities, by industry, was 5% for banks, 12% for broker-dealers, 2% for GSEs 

and 3% for insurance companies. Among the small issuers, the option was selected for 0.01% of 

total liabilities. 
71

Exhibit II.27: Percentage of Liabilities Reported under the FVO by Industry – As of First QuarterEnd 2008 

BrokerDealers, 12%

5% 0% GSEs, 2% 3%

0%

20%

40%

60%

80%

100%

Banking BrokerDealersCredit

Institutions

GSEs Insurance

Industry

Percentage

Banks 

With respect to banks within the large issuer group, FVO liabilities represented 43% of total 

liabilities at fair value. Liabilities elected under the FVO consisted of repurchase agreements 

(48%), long-term debt (39%), short-term debt (5%), interest-bearing deposits (3%), and 

beneficial interests in variable interest entities (1%). No banks in the small issuer group selected 

the FVO for liabilities. 

Broker-Dealers 

Of the four broker-dealers within the large issuer group, two elected to fair value liabilities under 

the FVO. FVO liabilities represented 37% of total liabilities at fair value. Liabilities elected 

under the FVO consisted of long-term debt (45%), repurchase agreements (40%), deposits (6%), 

short-term debt (5%), and other liabilities (4%). The remaining two broker-dealers also elected 

to fair value liabilities under the FVO but, as noted above, end-of-period information was not 

available. The one broker-dealer in the small issuer group did not select the FVO for liabilities. 

Credit Institutions

No credit institutions in the sample elected to fair value liabilities under the FVO. 

GSEs 

FVO liabilities represented 87% of total liabilities at fair value (however, liabilities at fair value 

are less than 2% of total liabilities). Liabilities elected under the FVO consisted of long-term 

debt (98%) and short-term debt (2%). There were no GSEs included in the small issuer group. 

Insurance 

With respect to insurance companies within the large issuer group, one company elected the 

FVO for liabilities. FVO liabilities for all insurance companies in the sample represented 56% of 
72

total liabilities at fair value. The liabilities elected consisted primarily of long-term debt and 

securities sold under repurchase agreements. One insurance company in the small issuer group 

elected the FVO for other liabilities, which represented 19% of that company’s total liabilities at 

fair value. 

iv. Comparison of Percentage of Liabilities Measured at 

Fair Value Before and After Adoption of SFAS No. 157 

and SFAS No. 159

Overall Analysis

Exhibit II.28 illustrates the change in the percentage of liabilities reported at fair value from 

year-end 2006 to first quarter-end 2008. There was an increase in liabilities reported at fair value 

from 8% as of year-end 2006 to 15% as of first quarter-end 2008. As illustrated in Exhibit II.26, 

entities elected to report 5% of their liabilities at fair value by using the FVO. Thus, it appears 

that FVO election would account for the majority of the increase in liabilities measured at fair 

value. 

Exhibit II.28: Percentage of Liabilities Measured at Fair Value over Time 

8%

15%

0%

20%

40%

60%

80%

100%

2006 Q1 2008

Period End

Percentage

Analysis by Issuer Industry

As depicted in Exhibit II.29, the percentage of liabilities at fair value increased most significantly 

from year-end 2006 to first quarter-end 2008 for the broker-dealer industry. 
73

Exhibit II.29: Percentage of Liabilities Measured at Fair Value over Time by Industry 

6%

24%

0% 0% 1% 11%

35%

1% 2% 5%

0%

20%

40%

60%

80%

100%

Banking

Broker-Dealers

Credit Institutions

GSEs

Insurance

Industry

Percentage

2006

Q1 2008

Banks 

The percentage of liabilities at fair value as compared to total liabilities increased from 6% as of 

year-end 2006 to 11% as of first quarter-end 2008. For all but two banks (which had an 

insignificant decrease), the amount of derivatives recorded at fair value increased from 0.3% to 

3.5% of total liabilities. Banks also had an increase in repurchase agreements measured at fair 

value as a result of the FVO. Three large banks reported large increases in the amount of longterm debt recorded at fair value as a result of the FVO. Further, trading liabilities reported at fair 

value as a percentage of total liabilities decreased from 6% to 3%. 

Broker-Dealers 

With respect to the broker-dealers, liabilities reported at fair value as a percentage of total 

liabilities increased from 24% as of year-end 2006 to 35% as of first quarter-end 2008. Trading 

liabilities and derivatives remained consistent as a percentage of total liabilities from year-end 

2006 to first quarter-end 2008. However, there was an increase of repurchase agreements 

measured at fair value. Two broker-dealers recorded some repurchase agreements at fair value 

under the FVO, which ranged from 9% to 14% of total liabilities as of first quarter-end 2008. 

Repurchase agreements were not recorded at fair value as of year-end 2006, as this was not 

allowed prior to the adoption of SFAS No. 159. The amount of debt recorded at fair value 

increased as a percentage of total liabilities. Specifically, the percentage of debt at fair value as 

of year-end 2006 ranged from 0% to 4%, whereas as of first quarter-end 2008, this percentage 

ranged from 4% to 7%. 

Credit Institutions 

This industry reported an insignificant amount of liabilities at fair value, and this percentage did 

not change significantly as a result of adopting SFAS No. 157 and SFAS No. 159. 
74

GSEs 

This industry reported an insignificant amount of liabilities at fair value, and this percentage did 

not change significantly as a result of adopting SFAS No. 157 and SFAS No. 159. 

Insurance 

Three insurance companies in the sample selected the FVO to measure certain liabilities. One of 

these companies accounted for 99% of the liabilities measured at fair value as a result of 

selecting the FVO. Use of the FVO was the primary reason for the increase in the amount of 

liabilities measured at fair value from year-end 2006 to first quarter-end 2008. 

b. Nature of Liabilities Measured at Fair Value on a Recurring 

Basis 

As illustrated in Exhibit II.30 below, 53% of all liabilities reported at fair value were either 

trading or derivative liabilities which were required to be measured at fair value. 

Accounting for the various types of liabilities is discussed in detail in Section I.D of this study. 

A brief discussion of the types of instruments that are included in these liability classes follows. 

Derivatives and Trading Account Liabilities

See discussion at Section II.B.1.b. 

Repurchase Agreements

Financial instruments purchased under agreements to resell and financial instruments sold under 

agreements to repurchase, principally U.S. government, federal agency, and investment-grade 

sovereign obligations, represent collateralized financing transactions. 

Exhibit II.30: Nature of Liabilities Measured at Fair Value – As of First Quarter-End 2008 

27%

18% 26%

16%

13%

Derivatives

Trading Accounts

Repurchase

Agreements

Long-Term Debt

Other*

*Includes short-term debt, interest bearing deposits, and other liabilities. 
75

An analysis of the sampled issuers illustrated that issuers used the FVO to measure structured 

notes, repurchase agreements, and other long-term liabilities at fair value. The elections which 

accounted for the remaining 47% of liabilities measured at fair value appear to be made 

primarily as a result of rules requiring bifurcation of derivatives embedded in some of these 

instruments and in other cases to avoid mismatch of measurement basis between the funding 

used to purchase assets and the related assets (such as funding used to purchase trading 

securities). 

c. Classification of Liabilities in Fair Value Hierarchy 

Exhibit II.31 below shows the classification of liabilities measured at fair value within the fair 

value hierarchy as of first quarter-end 2008. As illustrated in this exhibit, a majority (84%) of 

the liabilities that were reported at fair value were Level 2 instruments for which inputs were 

observable, followed by Level 1 instruments which had quoted prices (11%). Level 3 

instruments comprised 5% of all liabilities that were reported at fair value. 

Exhibit II.31: Fair Value Hierarchy Classification of Liabilities at Fair Value – As of First QuarterEnd 2008 

11%

84%

5%

Level 1

Level 2

Level 3

i. Fair Value Hierarchy Classification over Time 

Analysis on Overall Basis

The change in the classification of liabilities from first quarter-end 2008 to third quarter-end 

2008 is illustrated in Exhibit II.32. The classification of liabilities remained consistent and 

unaffected by changes in market conditions between the first and third quarters, as depicted by 

Exhibit II.32.
76

Exhibit II.32: Fair Value Hierarchy Classification of Liabilities Measured at Fair Value over Time 

11%

84%

9% 5%

86%

8% 5%

86%

6%

0%

20%

40%

60%

80%

100%

Level 1 Level 2 Level 3

Classification

Percentage

Q1 2008

Q1 2008 excluding Q3 NonFilers

Q3 YTD 2008

Analysis by Issuer Industry

Exhibit II.33 illustrates the classification of liabilities reported at fair value by issuer industry, 

greater than 75% of which were classified as Level 2 for all industries. Other than brokerdealers which had the greatest percentage of Level 1 liabilities and the lowest percentage of 

Level 2 liabilities, and the insurance industry which had the greatest percentage of liabilities 

classified as Level 3, most industries had consistent classifications of fair value measurements of 

liabilities. 

Exhibit II.33: Fair Value Hierarchy Classification of Liabilities Measured at Fair Value by 

Industry – As of First Quarter-End 2008 

6%

20%

0% 0% 0%

90%

75%

99% 96%

76%

5% 5% 1% 4%

24%

0%

20%

40%

60%

80%

100%

Banking

Broker-Dealers

Credit Institutions

GSEs

Insurance

Industry

Percentage

Level 1

Level 2

Level 3

Banking 

Of bank liabilities reported at fair value, 90% were measured using Level 2 inputs, followed by 

6% using Level 1 inputs, and 5% using Level 3 inputs. Of the liabilities measured using Level 2 

inputs, derivatives comprised 88%. This composition was consistent with the nature of these 
77

liabilities. Due to their nature, derivatives were typically not traded in active markets where 

quoted prices were available and were therefore included within Levels 2 or 3. 

Broker-Dealers 

Twenty percent of broker-dealer liabilities reported at fair value as of first quarter-end 2008 were 

within the Level 1 category. Accordingly, this industry had the highest percentage of Level 1 

liabilities. Trading liabilities comprised 76% of these Level 1 liabilities. Due to the nature of 

their business, broker-dealers had a substantial amount of trading liabilities, which included 

items that were valued using Level 1 inputs, such as short positions on U.S. government 

securities and equities listed in an active market. Derivative liabilities constituted 64% of all 

Level 2 liabilities for broker-dealers. 

 

Credit Institutions 

Credit institutions had an immaterial amount of liabilities measured at fair value and almost all 

of these liabilities were classified as Level 2. The liabilities measured at fair value included 

long-term and short-term debt and customer time deposits. This industry grouping reported an 

insignificant amount of derivatives. 

GSEs 

Liabilities measured at fair value were 2% of total liabilities for GSEs. Ninety-six percent of 

total liabilities measured at fair value were classified using Level 2 inputs. Of the liabilities 

measured using Level 2 inputs, derivatives comprised 64% and long- and short-term debt 

instruments comprised 35%. 

Insurance 

Insurance companies had virtually no Level 1 liabilities and the highest percentage of Level 3 

liabilities among the various industry groups. Among the various liabilities classes, derivative 

liabilities were prevalent among insurance companies and constituted 38% of total liabilities at 

fair value and 86% of liabilities classified at Level 3. Insurance companies often carried 

portfolios of specialized derivatives, such as credit default swaps and other derivatives, for which 

inputs were not observable, resulting in the larger proportion of Level 3 liabilities.

Analysis by Issuer Size

As mentioned earlier in this section, the liabilities of large issuers comprised over 99% of all 

liabilities that are reported at fair value. Exhibit II.34 below illustrates that small issuers had 

greater Level 3 liabilities. In dollars, the large issuers accounted for $2.5 trillion of total 

liabilities at fair value compared to $88 million for the small issuers. 
78

Exhibit II.34: Fair Value Hierarchy Classification of Liabilities Measured at Fair Value by Issuer 

Size – As of First Quarter-End 2008

11%

84%

5%

15% 13%

72%

0%

20%

40%

60%

80%

100%

Level 1 Level 2 Level 3

Classification

Percentage

Large Issuers

Small Issuers

 ii. Distribution of Issuers by Percentage of Liabilities 

Classified as Level 3 

Exhibit II.35 presents the distribution of issuers based on their percentage of liabilities classified 

as Level 3. A majority of the issuers in the sample (42 issuers in total) had either no liabilities at 

fair value or liabilities at fair value that constituted less than 1% of total liabilities. From the 

remaining eight issuers, two had liabilities reported at fair value that ranged between 5% and 

10% of total liabilities. One was an insurance company and the other a broker-dealer. Level 3 

liabilities for these companies included derivative contracts on subprime assets, asset-backed 

securities, collateralized debt obligations, credit derivatives on corporate and other non-mortgage 

underlyings that incorporate unobservable correlations, equity and currency derivative contracts 

that were long-dated and / or had unobservable correlation, structured notes with embedded 

equity and commodity derivatives that were long-dated and / or had unobservable correlation, 

and certain non-recourse long-term borrowings issued by consolidated special purpose entities. 
79

Exhibit II.35: Distribution of Issuers by Percentage of Liabilities at Level 3 – As of First QuarterEnd 2008127

36%

48%

12%

4%

0%

20%

40%

60%

80%

100%

0% 0% < X ≤ 1% 1% < X ≤ 5% 5% < X ≤ 10%

Percentage of Liabilities Classified as Level 3

Percentage of Sample

3. Equity 

a. SFAS No. 157 Adoption

Overall Analysis

As mentioned earlier, SFAS No. 157 clarified how to measure fair value as opposed to requiring 

that fair value be used as a measurement attribute. Therefore, to the extent there was a difference 

in the fair value resulting from applying the new definition, that difference was generally 

required to be accounted for prospectively. SFAS No. 157 provided for limited retrospective 

application in three situations. Specifically, SFAS No. 157: (1) disallowed the use of a blockage 

factor or discount in computing the value of large blocks of equity holdings, (2) permitted gain 

(loss) recognition on instruments for which gains or losses at inception could not previously be 

recorded because their fair values were not observable, and (3) permitted a change in the fair 

value measurement for hybrid financial instruments. The cumulative effect of measurement 

changes was required to be recognized and presented separately in equity. 

Upon adoption of SFAS No. 157, these changes had a limited transition effect on issuers in the 

sample, as is illustrated in Exhibit II.36 below.128 Specifically, as illustrated in Exhibit II.36, 

70% of the overall sample had no impact upon adoption of SFAS No. 157 and no issuers had an 

impact over 5% of equity. Twelve companies reported cumulative gains on transition totaling 

$731 million, whereas three issuers reported cumulative losses on transition totaling $247 

million. The gains ranged from $1 million to $287 million. The losses ranged from $11 million 

to $220 million. Thirty-five issuers reported no impact as a result of the transition to SFAS No. 

157, 14 issuers reported an impact between 0% and 1%, and one issuer reported an impact 

 

127 Fourteen issuers did not have any liabilities reported at fair value and have been excluded from this analysis. 

128 Some issuers in the sample “early adopted” SFAS No. 157 for fiscal 2007 and other issuers adopted the standard 

for fiscal 2008. In preparing this analysis, the transition impact for all issuers was combined regardless of year of 

adoption. 
80

between 1% and 5% (a reduction of 1.2%) of equity. In some instances, SFAS No. 157 also had 

a prospective impact on the income statement where the methodology of determining the fair 

value estimate had to be changed to be in accordance with the SFAS No. 157’s definition, as 

discussed further below. 

Exhibit II.36: SFAS No. 157 Transition Adjustment as a Percentage of Equity 

70%

28%

2%

0%

0% < X ≤ 1%

1% < X ≤ 5%

 

Analysis by Issuer Industry

While Exhibit II.37 illustrates the limited impact of applying certain provisions of SFAS No. 157 

upon adoption by industry, the majority of the definitional provisions of the standard were 

required to be applied only on a prospective basis. The impact of prospective application of 

SFAS No. 157 varied based on industry groupings. However, since disclosure about the impact 

of prospective application was not required and was, in many cases, not provided, there is a 

varying degree of information available. The discussion following Exhibit II.37 describes both 

the retrospective and prospective impacts (to the extent available) of transitioning to the new 

definition of fair value on each industry. 

Exhibit II.37: SFAS No. 157 Transition Adjustment as a Percentage of Equity by Industry 

0%

20%

40%

60%

80%

100%

0% 0% < X ≤

1%

1% < X ≤

5%

5% < X ≤

10%

> 10%

Percentage Impact on Equity

Percentage

Banking

Broker-Dealers

Credit Institutions

GSEs

Insurance
81

Banking 

Twenty-one banks reported no retrospective impact on equity as a result of adopting SFAS No. 

157 and six banks reported an impact between 0% and 1% of equity. The primary identifiable 

transition impact of SFAS No. 157 on the banks in the sample was on a prospective basis as a 

result of a change in the valuation methodology for their principal investments. Principal 

investments were investments made by the banks in the equity of other private entities. These 

investments tended to be less liquid and previously may not have been reported at fair value by 

certain financial institutions. The valuation of these investments was subject to significant 

management estimates. Management historically used sales or other transactions in these 

investments by others as the basis for recording any upward or downward adjustment from the 

initial transaction price. Based on public filings, the existence of sufficient market evidence and 

SFAS No. 157’s requirement to use a market participant’s assumptions value impacted the 

valuation of these investments for certain banks; however, there is not sufficient disclosure 

provided to isolate the specific impact. 

Broker-Dealers 

One broker-dealer reported no retrospective impact on equity as a result of adopting SFAS No. 

157 and four broker-dealers reported an impact between 0% and 1% of equity. Similar to banks, 

broker-dealers also had a prospective impact as a result of adopting SFAS No. 157. The 

prospective impact stemmed from a change in the valuation methodology of principal investing 

assets, a change in the valuation methodology of derivative and trading liabilities, and the impact 

associated with transaction costs. Since broker-dealers had sizable derivatives portfolios and 

larger numbers of liabilities that are measured at fair value, SFAS No. 157 also impacted their 

fair value methodology as a result of the consideration of issuer creditworthiness. Other than one 

broker-dealer that reported a significant prospective impact ($500 million) on net income as a 

result of a change in the methodology of valuing principal investments, the prospective impact of 

SFAS No. 157 adoption was not significant for broker-dealers. 

Credit Institutions 

This industry did not report any significant impacts from adopting SFAS No. 157. 

GSEs

This industry did not report any significant impacts from adopting SFAS No. 157. 

Insurance 

Eight insurance companies reported no retrospective impact on equity as a result of adopting 

SFAS No. 157, three insurance companies reported an impact between 0% and 1% of equity, and 

one insurance company reported an impact between 1% and 5% of equity (1.2% of equity). 

Before the issuance of SFAS No. 157, insurance companies appeared to rely on internal 

assumptions and limited observable inputs in valuing complex investments. Additionally, 

changes in issuer creditworthiness did not appear to be included in the measurement of liabilities. 
82

Insurance companies’ fair value estimates were therefore prospectively impacted by SFAS No. 

157’s requirement to maximize observable inputs when developing fair value measurements and 

including changes in issuer creditworthiness in determining the fair value of liabilities. Five 

insurance companies in the sample disclosed the prospective after–tax impact of SFAS No. 157 

adoption, which generally resulted from changes in key fair value assumptions as these were 

aligned with those of the market. While, in several cases, issuer disclosures were not specific, in 

the case where the impact was identifiable, the after-tax amounts ranged from a $220 million loss 

to a $1.8 billion gain. 

 

b. SFAS No. 159 Adoption 

Overall Analysis

As discussed earlier, SFAS No. 159 provided issuers with an opportunity to elect to expand the 

use of fair value. At transition, companies had the ability to elect the FVO for previously owned 

assets and liabilities. The transition provisions required that any difference between the fair 

value and carrying value of the item on the adoption date be recorded as an adjustment in equity. 

For the sampled issuers, the analysis illustrates that the FVO was used for certain loans, loan 

commitments, structured notes, and AFS securities. SFAS No. 159 also requires companies to 

disclose the reasons for electing the FVO. Based on a review of the disclosures, reasons cited in 

electing fair value as a measurement attribute included: (1) to avoid complex hedge accounting 

requirements for items that were hedged; (2) to avoid mismatching between assets and their 

related funding; and (3) to have a common measurement basis for items that otherwise would not 

qualify for hedge accounting. As noted earlier, the FVO was selected by issuers in the sample on 

4% of total assets and 5% of total liabilities upon adoption.129 The transition impact of 

expanding the use of fair value as a percentage of equity is illustrated in Exhibit II.38 below. 

Exhibit II.38: SFAS No. 159 Transition Adjustment as a Percentage of Equity 

66%

26%

6%

2%

0%

0%

0% < X ≤ 1%

1% < X ≤ 5%

5% < X ≤ 10%

> 10%

 

129 Some issuers in the sample “early adopted” SFAS No. 159 for fiscal 2007 and other issuers adopted the standard 

for fiscal 2008. In preparing this analysis, the transition impact for all issuers was combined regardless of year of 

adoption. 
83

This exhibit illustrates that for 66% of the issuers included in the sample, there was no transition 

impact from adopting SFAS No. 159. Seventeen issuers in the sample reported transition 

adjustments. None of the issuers in the sample reported a transition impact of greater than 10% 

of equity and one issuer reported an impact greater than 5% but less than 10%. In dollar 

amounts, the transition impact from adopting SFAS No. 159 totaled a net $88 million gain for all 

the issuers in the sample. Eleven issuers reported gains totaling $2 billion and six issuers 

reported losses totaling $1.9 billion. Losses at transition ranged from $36 million to $1.1 billion 

and gains at transition ranged from $8 million to $1 billion.

Analysis by Issuer Industry

Similar to the impact of SFAS No. 157 adoption, adoption of SFAS No. 159 generally did not 

have a significant effect on equity by industry. Exhibit II.39 below illustrates that GSEs and 

insurance companies were most impacted by the adoption of SFAS No. 159. As illustrated in 

Exhibit II.39, GSEs made the greatest use of the election, reporting a transition adjustment of 2% 

of equity. 

Exhibit II.39: SFAS No. 159 Transition Adjustment as a Percentage of Equity by Industry 

0%

20%

40%

60%

80%

100%

0% 0% < X ≤

1%

1% < X ≤

5%

5% < X ≤

10%

> 10%

Percentage Impact on Equity

Percentage

Banking

Broker-Dealers

Credit Institutions

GSEs

Insurance

Banking 

Of the eight banks reporting transition adjustments, five reported gains cumulatively totaling 

$491 million and three reported losses cumulatively totaling $524 million. No other banks in the 

sample reported any transition adjustments. 

Broker-Dealers 

All but one broker-dealer reported a transition impact as a result of adoption of SFAS No. 159. 

However, in all cases, the impact was less than 1% of equity. Gains recorded on transition 

ranged from $22 million to $102 million and losses ranged from $45 million to $185 million. 

Credit Institutions 

Credit institutions did not report any transition impact as a result of adoption of SFAS No. 159. 
84

GSEs 

One GSE reported a significant gain ($1 billion) in equity as a result of adopting SFAS No. 159. 

In this instance, the option was elected for certain AFS mortgage-related securities that were 

identified as economic offsets to the changes in fair value of the guarantee assets and 

investments in securities classified as AFS securities. For GSEs, the transition impact primarily 

resulted in a reclassification of amounts that were deferred in accumulated OCI to retained 

earnings. The two other GSEs reported gains on transition to SFAS No. 159 of $281 million in 

total (4% and 0.2% of equity). 

Insurance 

One insurance company reported a significant loss ($1.1 billion) as a result of adopting SFAS 

No. 159. The FVO was utilized to closely align the financial reporting and economic 

performance of hedging programs for certain life and investment-linked life insurance products. 

The transition impact also included amounts related to changes in own creditworthiness for long 

term borrowings for which the option was selected. Only one other insurance company reported 

an impact from transition to SFAS No. 159, which was less than 1% of equity. 

c. Accumulated Other Comprehensive Income 

Overall Analysis

Two types of instruments were measured at fair value on the balance sheet where changes in 

their fair value are not reported in income but rather in equity.130 Specifically, these were AFS 

securities and derivative instruments that were designated in cash flow hedging relationships. 

For AFS securities, the impact was recognized in the income statement only when the security 

was impaired or sold. For derivative instruments used in cash flow hedging relationships, the 

impact in the income statement was recognized in the same period as the hedged cash flows. 

AFS Securities 

Exhibit II.40 illustrates the unrealized gains or losses recorded in accumulated OCI. Exhibit 

II.40 indicates that for the first quarter of 2008, two issuers reported unrealized gains that ranged 

between $1 and $5 billion deferred in accumulated OCI, seven issuers reported unrealized losses 

in excess of $1 billion and less than $10 billion which had been recorded in OCI, and one issuer 

reported unrealized losses exceeding $10 billion. Of the issuers studied, a total of $39 billion in 

unrealized losses (carrying value greater than fair value) had been deferred in accumulated OCI 

compared to $25 billion in unrealized gains (three issuers comprised $25 billion of these 

unrealized gains and 13 issuers collectively reported $600 million in unrealized gains deferred in 

accumulated OCI). 

 

130 The Staff was unable to obtain disaggregated information from the filings of five banks; these banks have been 

excluded from the analyses in this subsection. 
85

There was a significant increase in the amount of deferred losses in accumulated OCI for the first 

three quarters of 2008. One issuer reported unrealized losses in excess of $20 billion, three 

issuers reported unrealized losses that ranged between $5 and $10 billion, and 12 issuers reported 

unrealized losses that ranged between $1 and $5 billion deferred in accumulated OCI. Only one 

issuer reported an unrealized gain in excess of $15 billion deferred in OCI and one issuer 

reported unrealized gains that ranged between $500 million and $1 billion. Of the issuers 

sampled, a total of $79 billion in unrealized losses (carrying value greater than fair value) had 

been deferred in accumulated OCI compared to $16.9 billion in unrealized gains (two issuers 

comprised $16.8 billion of these unrealized gains and six issuers collectively had $39 million in 

unrealized gains deferred in accumulated OCI). 

Since the dollar amounts of gains and loss deferred were significant, an analysis of these deferred 

amounts as a percentage of the AFS asset class was performed. Net unrealized losses as a 

percentage of AFS securities were 0.5% as of first quarter-end 2008 and 2% as of third quarterend 2008. The highest percentage of gains and losses deferred in accumulated OCI as a 

percentage of AFS security carrying value were 17% for unrealized gains and 69% for unrealized 

losses as of first quarter-end 2008. The highest percentage of gains and losses deferred in 

accumulated OCI as a percentage of AFS security carrying value were 15% for unrealized gains 

and 10% for unrealized losses as of third quarter-end 2008. As of first quarter-end 2008 and 

third quarter-end 2008, there were 40 issuers and 37 issuers, respectively, in the sample for 

which deferred unrealized gains or losses constituted less than 5% of the total AFS security 

carrying value. 

By industry, broker-dealers had the largest percentage of net losses deferred in accumulated OCI 

for both first quarter- and third quarter-end 2008, at 8% and 9% of their total AFS securities. 

Broker-dealer AFS portfolios were not significant relative to other industry groups (2% and 1% 

of total AFS securities for all issuers as of the first and third quarters, respectively). Brokerdealers were followed by GSEs, which had net losses of 2% and 3% of total AFS securities for 

first quarter- and third quarter-end 2008, respectively. 

In terms of dollar amounts, one GSE reported unrealized losses in excess of $15 billion and one 

insurance company reported unrealized gains of greater than $15 billion, representing 3% and 

17% of the AFS securities portfolio, respectively, as of first quarter-end 2008. As of third 

quarter-end 2008, in terms of dollars, one GSE reported unrealized losses in excess of $20 billion 

and one insurance company reported unrealized gains of greater than $15 billion, representing 

5% and 15% of the AFS securities portfolio, respectively. 
86

Exhibit II.40: Distribution of Issuers by Amount of Accumulated Other Comprehensive Income 

0%

20%

40%

60%

80%

100%

<

($10,000)($10,000)

≤ X <

($1,000)

($1,000) ≤

X < $0

$0 ≤ X <

$1,000

$1,000 ≤

X <

$5,000 

≥ $5,000

Amount of Accumulated Other Comprehensive Income

Percentage of Sample

Q1 2008 Q1 2008 Excluding Q3 Non-Filers Q3 2008

Derivatives Designated in Cash Flow Hedging Relationships 

As of first quarter-end 2008, total unrealized losses and gains recorded in accumulated OCI on 

derivatives designated in cash flow relationships totaled $18 billion and $2 billion, respectively. 

Four issuers recorded unrealized losses on derivative instruments in excess of $1 billion but less 

than $5 billion. The combined total loss deferred by these four issuers was $15 billion. Fifteen 

issuers recorded losses that ranged from $1 million to $687 million for a collective total of $3 

billion. A total of seven issuers recorded unrealized gains on derivatives in accumulated OCI 

ranging from $44 million to $619 million for a combined deferred gain of $1.7 billion. 

4. Income Statement 

While the mandate calls for a study of the impact of fair value accounting on the balance sheet of 

financial institutions, to provide a more complete understanding of the impact of fair value 

accounting, this section considers the income statement impact, given the focus on net income, 

as discussed in Section I.B. The scope of this study was therefore expanded to provide an 

analysis of the impact on income and included information obtained from the footnotes and 

MD&A. While the section provides an assessment of the impact of fair value accounting on the 

income statement, this analysis is limited by existing presentation and disclosure requirements 

that, in many cases, do not provide for or facilitate the separate identification of fair value 

measures. Thus, this subsection should be viewed as providing approximations and should not 

be considered to represent a full assessment of the impact. 

In this subsection, the Staff analyzed gains and losses recorded in income as a percentage of 

issuer equity at the beginning of the related period. The exhibits in this subsection are based on 

the absolute value of net gains and losses by issuer, which were summed on an overall basis for 

analysis. Where the related discussion reflects the same convention, the term “absolute basis” is 

used. 
87

In addition, to account for differences in the timeframes analyzed (12 months for 2006, 12 

months for 2007, three months for the first quarter of 2008, and nine months for year-to-date 

third quarter 2008, as applicable), 2008 data was annualized when presented for comparative 

purposes in the exhibits below. In the discussion, actual amounts are presented, unless otherwise 

stated.131 

U.S. GAAP has historically not provided prescriptive guidance on how items are presented in the 

income statement. With respect to items that are measured at fair value, companies often do not 

present changes in fair value on a pre-specified line item or separate these fair value changes 

between realized and unrealized components. In certain instances, accounting rules require 

companies to disclose in the footnotes where in the income statement a company has recorded 

the impact of certain fair value changes. 

SFAS No. 157 significantly expanded the disclosures required for items measured at fair value. 

Specifically, with respect to Level 3 measurement, the disclosures are extensive and require that 

companies present a rollforward of Level 3 measurement indicating how much of the 

measurement continues to be unrealized and how much is realized. While this disclosure has 

been useful, it is still difficult to determine the overall income statement impact related to the 

changes in fair value. In many instances the impact of fair value measurement is recorded in 

more than one line item. For example, debt securities measured at fair value may have a 

component of the value related to the interest presented in the interest line item and all other 

changes in the value presented elsewhere in the income statement. 

Current requirements with respect to financial statement presentation generally do not require 

companies to separately display the impact of fair value measurement or to differentiate the 

impact in the income statement between realized and unrealized gains and losses for instruments 

measured at fair value. As a result, the analysis of the impact of fair value measurement only 

included those items for which changes in fair value are readily apparent on the income 

statement. 

a. Recurring Fair Value Measurements

i. Recurring Mark-to-Market Adjustments 

The objective of this analysis was to determine the approximate impact of recurring fair value 

measurements on equity of financial institutions overall and by issuer industry progressively over 

time from the first quarter of 2008 to the year-to-date third quarter of 2008. That is, this analysis 

was performed to gauge the impact of gains and losses recognized in the income statement as a 

result of mark-to-market accounting. For purposes of this analysis, income statement impact was 

identified either by a review of the income statement or based on disclosure in the footnotes and 

MD&A. Specifically, this review included trading revenues, items optionally reported at fair 

value as a result of the fair value elections, and changes in values of instruments classified as 

 

131 The Staff uses the term “comparable nine-month basis” to refer to comparisons between the first quarter and first 

three quarters of 2008, in which the first quarter 2008 gains (losses) are multiplied by three. Where the Staff uses 

the term “annualized,” gains (losses) in the first quarter of 2008 and the first three quarters of 2008 are multiplied by 

four and 4/3, respectively. 
88

Level 3. The income statement impact of certain items could not be determined, such as the 

amount of changes in the fair value of Level 1 and Level 2 derivatives. 

The impact of fair value measurement on the income statement of insurance companies was 

analyzed separately, as discussed further below. 

Overall Analysis

On an overall basis, excluding the insurance companies, this analysis covered approximately 

90% of instruments recorded at fair value (those instruments for which recurring fair value 

impacts on the income statement could be approximately identified) as of first quarter- and third 

quarter-end 2008. Items reported at fair value on a recurring basis, using absolute values for 

each issuer in the sample, resulted in an 11% and a 10% impact on equity (on a comparable ninemonth basis) for the first quarter and the first three quarters of 2008, respectively. The impact on 

equity was 3% and 4% increase (on a comparable nine-month basis) for the first quarter and the 

first three quarters of 2008, respectively, when the gains and losses of items reported at fair value 

on a recurring basis were netted together for all issuers in the sample. 

However, income from trading activities was significantly lower in 2008 (on an annualized 

basis), when compared to 2007. Therefore, the increase to equity from recurring fair value 

measurements in 2008 was lower compared to increase in equity from recurring fair value 

measurements in 2007. Trading income is a significant source of revenue for broker-dealers, an 

industry group that had the greatest percentage of assets whose changes in fair value impacted 

the income statement. Annualized trading income for 2008 declined by 65% from 2007 and 

resulted at least partly in reduced profitability for the broker-dealers and banks who were 

engaged in significant trading activities. The decline in trading income was partly offset by 

increases in income as a result of changes in own creditworthiness included in fair value 

measurements of certain liabilities. 

For the first quarter 2008, the sum of all fair value gains and losses, netted by issuer, related to 

recurring fair value adjustments (on a comparable nine-month basis) were $56 billion and ($43) 

billion, respectively, for the sample, excluding insurance companies. The resulting net fair value 

gain of $13 billion consisted primarily of net trading gains of $32 billion, net MSR losses of 

($16) billion, net derivative losses of ($9) billion, and net gains related to liabilities (e.g., time 

deposits, debt, other liabilities) of $2 billion. The remaining fair value gain of $4 billion was 

related to the remaining asset classes, such as loans, guarantee assets, reverse repurchase 

agreements and other investments. The range of recurring fair value gain adjustments recorded 

ranged from $40 thousand to $9 billion, and the range of recurring fair value loss adjustments 

recorded was from ($161) million to ($4) billion. 

For the first quarter of 2008, no issuers in the sample had a percentage impact of recurring fair 

value measurements greater than 15% of equity. The percentage impact on equity ranged from a 

decrease of 10% to an increase of 11%. Sixteen issuers reported increases in equity. For all 

except three issuers, this increase was less than 5% of equity. Ten issuers reported decreases in 

equity. For all except three issuers, this decrease was less than 5% of equity. Generally, for the 

first quarter of 2008, credit institutions reported the smallest impact on equity from recurring fair 
89

value measurements. Banks reported the largest impact in amount, while broker-dealers reported 

the largest impact as a percentage of overall equity. 

For the first three quarters of 2008, the sum of all fair value gains and losses, netted by issuer, 

related to recurring fair value adjustments was $56.5 billion and ($26.2) billion, respectively, for 

all issuers in the sample, excluding insurance companies. The resulting net fair value gain of 

$30.3 billion consisted primarily of net trading gains of $15.1 billion, net MSR losses of ($1.3) 

billion, net derivative losses of ($6.0) billion, and net gains related to liabilities (e.g., deposits, 

debt, other liabilities) of $21.0 billion. The remaining fair value gain of $1.5 billion was related 

to the remaining asset and liabilities classes, such as loans, guarantee assets, repurchase 

agreements and other investments. The range of recurring fair value gain adjustments recorded 

ranged from $60 thousand to $19.8 billion, and the range of recurring fair value loss adjustments 

recorded ranged from ($20) thousand to ($13.1) billion. 

For the first three quarters of 2008, six issuers reported a percentage impact of recurring fair 

value measurements of greater than 15% of equity, and two issuers reported a percentage impact 

ranging from 5% to 15% of equity. The percentage impact on equity ranged from a decrease of 

41% to an increase of 29%. Seventeen issuers reported increases in stockholders equity. For all 

except five issuers, this increase was less than 5% of equity. Nine issuers reported decreases in 

equity. For all except three issuers, this decrease was less than 5% of equity. Generally, for the 

first three quarters of 2008, credit institutions were impacted the least by recurring fair value 

measurements, whereas banks had the greatest impact in dollars and broker-dealers had the 

greatest impact as a percentage of overall equity. 

Insurance

Due to limitations in available information on a disaggregated basis, the Staff could not precisely 

analyze the fair value impact on insurance company income statements for approximately 13% 

of assets reported as of first quarter- and third quarter-end 2008. These assets generally 

consisted of trading assets, derivatives, and other invested assets such as hedge funds and private 

equity investments. The remaining 87% of assets reported at fair value consisted of AFS 

securities and separate account assets, neither of which normally affects income on a recurring 

basis. However, AFS securities did produce increasing OTTI write-downs during 2008, as 

discussed below. 

ii. Level 3 Fair Value Measurements

Expanded disclosures are required for items which fall within Level 3. The following is an 

analysis of the impact of the change in the fair value of Level 3 instruments record in the income 

statement evaluated as a percentage of equity. 

The analysis illustrates that Level 3 assets comprised 9%, or $1,049 billion, of total assets at fair 

value, and Level 3 liabilities comprised 5%, or $326 billion, of total liabilities at fair value as of 

first quarter-end 2008. From first quarter-end to third quarter-end 2008, there was an increase in 

the percentage of assets and liabilities classified as Level 3, from 9% to 10%, or $1,023 billion, 

for assets and from 5% to 6%, or $307 billion, for liabilities. 
90

Despite the lower percentage of financial instruments measured using Level 3 inputs, changes in 

the fair value of Level 3 instruments had a significant impact on equity. On a net basis, gains on 

Level 3 instruments were 6% of equity for both the first quarter and first three quarters of 2008 

(on a comparable nine-month basis). Using absolute dollars, the impact of Level 3 instruments 

was 10% and 7% of equity (on a comparable nine-month basis) for the first quarter and first 

three quarters of 2008, respectively, as shown in Exhibit II.41 below. 

For the first quarter of 2008, for the sample overall, the net unrealized loss related to Level 3 

assets on a comparable nine-month basis was ($61.2) billion, and the net unrealized loss related 

to Level 3 liabilities was ($9.8) billion. The unrealized gains (losses) related to Level 3 assets 

ranged from a $6.4 billion gain to a ($12.9) billion loss. The unrealized gains (losses) related to 

Level 3 liabilities ranged from a $1.2 billion gain to a ($1.7) billion loss. Eighteen issuers in the 

sample had no impact of Level 3 instruments in equity. Ten issuers had a positive impact in the 

income statement, and therefore to equity, of $9.4 billion, with specific issuers ranging from $2 

million to $5.6 billion. Twenty-two issuers had a negative impact in the income statement and, 

therefore to equity, of $33 billion, with specific issuers losses ranging from $10 million to $13 

billion. 

For the first three quarters of 2008, for the sample overall, the net unrealized loss related to Level 

3 assets was ($61.3) billion, and the net unrealized loss related to Level 3 liabilities was ($13.1) 

billion. The unrealized gains (losses) related to Level 3 assets ranged from a $3.8 billion gain to 

a ($18.8) billion loss. The unrealized gains (losses) related to Level 3 liabilities ranged from a 

$7.2 billion gain to a ($18.7) billion loss. Eighteen issuers in the sample had no impact of Level 

3 instruments in equity. Six issuers reported a positive impact in the income statement, and 

therefore to equity, of $6.9 billion, with specific issuers ranging from $1.9 million to $4.4 billion. 

Twenty-four issuers had a negative impact in the income statement and, therefore to equity, of 

$81.4 billion, with specific issuer losses ranging from $50 million to $28.8 billion. Insurance 

companies, which reported the highest percentage of Level 3 liabilities, also recorded the highest 

losses on these Level 3 liabilities ($23 billion). 

 

From an industry perspective, the most significant impact of Level 3 instruments in the first 

quarter of 2008 was on the broker-dealer industry, and the most significant impact was on the 

GSE industry for the first three quarters of 2008. For these industries, Level 3 instruments on an 

absolute and a comparable nine-month basis were 23% and 17% of equity in each period, 

respectively. Credit institutions reported the least significant impact from Level 3 measurements 

for both the first quarter and the first three quarters of 2008, at 1% of equity in each period on an 

absolute basis. 
91

Exhibit II.41: Impact on Equity from Level 3-Related Gains / Losses Recorded in Income132 

10% 10% 7%

0%

20%

40%

60%

80%

100%

Q1 2008

(Comparable NineMonth Basis)

Q1 2008 excluding

Q3 Non-Filers

(Comparable NineMonth Basis)

Q3 YTD 2008

Period

Percentage

iii. Impact of Changes in Creditworthiness in Measuring 

Liabilities

For the first quarter of 2008, for the sample overall, 15%, or $2,457 billion, of total liabilities of 

financial institutions were reported at fair value, and 5%, or $708 billion, of total liabilities were 

reported at fair value as a result of the FVO election made by these issuers. SFAS No. 157 

requires that companies incorporate the change in their own creditworthiness in determining the 

fair value of liabilities. Further, SFAS No. 159, which provides the option to make an election to 

fair value certain liabilities, requires disclosure to the extent that changes in own 

creditworthiness impact the measurement of fair value. The following is an analysis of the 

impact of fair value changes associated with changes in an issuer’s own creditworthiness. This 

analysis is performed based upon amounts disclosed only for those liabilities on which the FVO 

was selected for both the first quarter and the first three quarters of 2008. 

The analysis indicated that the total impact on income and equity from changes in own 

creditworthiness included in the fair value for liabilities was a gain of $6.8 billion and $17 billion 

for the first quarter and first three quarters of 2008, respectively. The analysis indicated that the 

total dollar amount reported related to changes in an issuer’s own creditworthiness ranged from a 

high of $2.1 billion gain to a low of $0 for the first quarter of 2008. This compares to a high of 

$5 billion and to a low of $0 for the first three quarters of 2008. Nine and 10 issuers in the 

sample reported an impact on fair value measurement of liabilities as a result of changes in own 

creditworthiness for the first quarter and first three quarters of 2008, respectively. 

The percentage impact on equity of changes in an issuer’s own creditworthiness varied 

significantly among the industries and can be partially explained by the greater use of the FVO 

election for liabilities in certain industries. On a comparable nine-month basis, at 8% of equity 

for the first quarter and first three quarters of 2008, the broker-dealer industry had the largest 

percentage impact as a result of change in their creditworthiness of issuers that selected the FVO 

 

132 The Staff used the absolute value of net gains and losses by issuer. These absolute values were summed on an 

overall basis, by issuer industry, and by issuer size, as appropriate, for analysis. 
92

for liabilities. Specifically, the analysis illustrated that, for the first quarter of 2008, all four of 

the broker-dealers in the large issuer sample selected the FVO for certain liabilities, as compared 

to six of the 13 large banks, two of the eight large insurance companies, two of the three large 

GSEs, and neither of the two credit institutions selecting the FVO for their liabilities. 

b. Non-Recurring Fair Value Measurements (Impairments)

The objective of this analysis is to determine how items measured at fair value on a nonrecurring basis impact the income statement and therefore equity. For example, securities held 

as AFS are written down in the income statement if they are deemed to be other than temporarily 

impaired. It should be noted that this subsequent measurement at fair value would be required 

even when items are measured at historical cost. 

For the purposes of this analysis, impairment losses recorded by issuers as a result of OTTI on 

AFS and HTM securities, valuation adjustments recorded on HFS loans, impairments recorded 

for goodwill, other intangibles and long-lived assets were totaled. The total recorded 

impairments were analyzed as a percentage of equity for financial institutions on an overall 

basis. Since these measurements of impairment were required before the issuance of SFAS No. 

157, the information was also analyzed on a progressive basis for 2006, 2007, and the first nine 

months of 2008. 

i. All Impairments 

Exhibit II.42 illustrates that impairment charges totaling $11 billion (or $34 billion on a 

comparable nine-month basis) and $91 billion represented 3% and 8% of equity (on a 

comparable nine-month basis) for the first quarter of 2008 and the first three quarters of 2008, 

respectively. Impairment charges for the first three quarters of 2008 substantially increased from 

the $5 billion (1% of equity), reported in 2006. This substantial increase reflects the 

deteriorating economic conditions which have led to a reduction in asset values. 

Exhibit II.42: Impact on Equity of Impairments Recorded in Income 

0% 1% 4% 10%

0%

20%

40%

60%

80%

100%

20062007

Q1 2008

Annualized

Q3 YTD

2008

Annualized

Period

Percentage

Actual

Excluding Q3

Non-Filers
93

Exhibit II.43 below depicts the nature of the impairment charges on a year-to-date basis through 

the third quarter of 2008. OTTI on securities comprised the largest component of total 

impairment charges, at $62 billion or 5.1% of equity, followed by goodwill impairment at $28 

billion or 2.3% of equity for the first three quarters of 2008. An insignificant amount of 

impairment charges were reported in other categories. The significant categories have been 

analyzed in greater detail below. 

Exhibit II.43: Nature of Impairment Charges – Year-to-Date Third Quarter 2008 

31%

0%

68% 1%

Goodwill Impairment

Other Intangible Asset

Impairment

Loans (Valuation

Allowance)

Securities OTTI

ii. Other-than-Temporary Impairments on Securities 

Exhibit II.43, above, indicated that OTTI was the largest component of total impairment charges 

recognized for the first three quarters of 2008. Exhibit II.44 below isolates the impact of OTTI. 

On a comparable nine-month basis, OTTI totaled $28 billion and $62 billion and constituted 2% 

and 5% of equity for the first quarter and first three quarters of 2008, respectively. 

For the first three quarters of 2008, at 17% of equity, or $13 billion, the GSEs reported the 

greatest impact from OTTI of the different industry groups, followed by the insurance industry at 

12% of equity, or $41 billion. For the GSEs, OTTI losses for the first three quarters of 2008 

ranged from $137 million to $10.2 billion, and OTTI losses for the insurance industry ranged 

from $61 million to $32.2 billion. Two issuers (one insurance company and one GSE) accounted 

for 68% of the OTTI for the first three quarters of 2008. 

While the impact on equity appears significant, when OTTI was measured against the asset value 

of AFS securities as a percentage of dollars amounts invested, on a comparable nine-month 

basis, these losses amounted to only 1% ($28 billion of impairment losses on securities portfolio 

of $2.9 trillion combined) and 2.1% ($62 billion of impairment losses on securities portfolios of 

$3 trillion combined) of the total AFS portfolio for insurance companies for the first quarter and 

first three quarters of 2008, respectively. Said differently, the decline in the asset value relative 

to the related asset portfolios was not a large percentage for any industry, even though equity 

was significantly impacted by this change. Accordingly, the significant impact on equity appears 

to have resulted from the overall leveraged position of these issuers. 
94

Exhibit II.44: Impact on Equity of Other-than-Temporary Impairments Recorded in Income 

0% 1% 3% 7%

0%

20%

40%

60%

80%

100%

2006 2007 Q1 2008

Annualized

Q3 YTD

2008

Annualized

Period

Percentage

Actual

Excluding Q3

Non-Filers

iii. Goodwill Impairment 

Two banks in the sample recognized significant goodwill impairments. Impairment tests were 

triggered primarily as a result of decline in market capitalization and / or acquisition transactions. 

The total goodwill impairment for the first three quarters of 2008 was $28 billion, and banks 

accounted for $27.3 billion of this impairment. The remaining $600 million in goodwill 

impairments was reported by issuers in the insurance industry. 

c. Key Income Statement Drivers Unrelated to Fair Value 

Measurements 

 

Though the scope of this study was limited to fair value measurements, the Staff expanded the 

income statement analysis to study the cause of declines in net income for financial institutions. 

This analysis was performed to provide perspective on other significant drivers of the income 

statement, thereby providing a backdrop to assess the role of fair value accounting as one of the 

many drivers. The Staff noted that net income for banking, credit institutions, and GSEs was 

most significantly impacted by the increase in the charge for provision for loan losses, which is a 

historical cost concept, as the provision for loan losses is primarily based on “incurred” losses. 

However, fair value plays a minor role in this estimate for certain loans. Specifically, to the 

extent a loan’s repayment is collateral-dependent, accounting rules incorporate the use of fair 

value of the underlying collateral in determining the amount of provision that needs to be 

recorded on a non-performing loan (loans more than 90 days delinquent and non-accrual loans, 

which are loans for which the bank is no longer accruing interest income because it no longer 

expects to collect all amounts due). 

As illustrated in Exhibit II.45, for the first three quarters of 2008, provisions were recorded at 

$121 billion and accounted for more than a 10% reduction in equity, as compared to annual 

periods of 2006 and 2007 when provisions were recorded at $27 billion and $62 billion, 

respectively, and reduced equity by 3% and 5%. 
95

Exhibit II.45: Impact on Equity of Provisions Recorded in Income 

3% 5% 11% 13%

0%

20%

40%

60%

80%

100%

2006 2007 Q1 2008

Annualized

Q3 YTD

2008

Annualized

Period

Percentage

Actual

Excluding Q3

Non-Filers

As mentioned earlier, losses related to higher than expected delinquencies on loans were 

experienced by all industries, excluding the broker-dealers. Broker-dealers carried trading 

portfolios which were marked-to-market through the income statement and therefore were likely 

to have larger percentages of trading gains / losses as opposed to impairments and provisions. 

While broker-dealers continued to post trading gains, these gains have declined from the prior 

year. In summary, all industries have been impacted by declining home prices, slow-down of the 

economy, and increased defaults on mortgage loans. For some industries, these losses 

manifested themselves in larger provision charges; for others, in larger OTTI charges; and for 

still others, in lower trading income. 

 

d. Conclusions 

As detailed in the filings of the issuers sampled, losses stemming from lending activities of banks 

have had a profound impact on all financial institutions in 2007-2008. These losses have 

impacted the banks directly through increased loan loss provisions, OTTI, and changes in fair 

value. Therefore, while fair value is used to measure certain assets such as trading securities and 

impairment losses on AFS securities, such declines in value were directionally consistent with 

the losses on the underlying loans and the current economic conditions, which impacted the 

value of these securities. 
96

 
97

III. Impact of Fair Value Accounting on Bank Failures in 2008 

This section of the study examines the impact of fair value accounting on U.S. bank failures in 

2008. Specifically, this section provides: 

• The methodology for studying bank failures; 

• An overview of the regulatory framework governing bank failures; 

• How fair value accounting affects U.S. GAAP reporting for banks, and how the failed banks 

accounted for their assets and liabilities; 

• Background information on the interaction between regulatory capital requirements and U.S. 

GAAP reporting; 

• Analysis of the causes of regulatory capital declines at the failed banks; 

• Evaluation of the circumstances surrounding each bank failure; and 

• Discussion of the impact of fair value accounting on other distressed financial institutions. 

Based on the analysis performed, the Staff believes that fair value accounting was not a primary 

underlying cause of the 2008 bank failures studied. For most of the failed banks studied, fair 

value accounting was applied in limited circumstances, and fair value losses recognized did not 

have a significant impact on the bank’s capital. For the failed banks that did recognize sizable 

fair value losses, it does not appear that the reporting of these losses was the reason the bank 

failed. Market concerns about these companies, as evidenced by their share price, appear to 

indicate that the marketplace factored in losses for these banks that had not been recognized in 

U.S. GAAP reported income. 

While most of the failed banks studied did not recognize significant fair value losses, each 

appears to have experienced default rates on assets held that significantly exceeded default rates 

experienced at non-failed banks of similar size. While declines in fair value and, to a lesser 

extent, U.S. GAAP-based incurred credit losses, are based on estimates, defaults on actual loans 

are much less subjective, as they indicate, in an objective way, the decline in quality of the 

underlying assets held by these banks. Even as it relates to defaults, the accounting for and 

reporting of defaults should not be viewed as causing a failure, but rather, a means of providing 

information used by market participants and others to evaluate an entity. 

A. Methodology for Studying Bank Failures 

In completing this portion of the study, the Staff characterized a bank133 failure as an insured 

depository institution in the U.S. that is closed by the appropriate state or federal chartering 

 

133 The Staff uses the term “bank” to refer to both banks and thrifts. 
98

authority in accordance with applicable law or regulations or by the appropriate Agency134 based 

on the authority provided under the Federal Deposit Insurance Act, entitled Prompt Corrective 

Action, or PCA.135 Banks that did not fail according to these criteria, but may have received 

other federal assistance or resolution in 2008, were not included in the detailed study.136 In 

addition, as Section 133(a)(2) limits its scope to the impact of bank failures, failures of non-bank 

financial institutions were not included in this portion of the study. However, Section III.G 

below provides a general discussion of such institutions. 

The Federal Deposit Insurance Corporation (“FDIC”) website posts information about bank 

failures from 1991 to present. According to the information released by the FDIC, as of 

December 1, 2008, there were 22 bank failures during 2008.137 

Separate analysis was performed for failed banks with assets less than $1 billion on an aggregate 

basis, those with assets between $1 billion and $10 billion on an aggregate basis, and those with 

assets greater than $10 billion on an individual basis. The groupings by size of bank were 

designed to ensure that data for smaller banks were not outweighed by data for larger banks. As 

of December 31, 2007, assets held in the failed banks with assets less than $1 billion represented 

1% of total assets held by failed banks, while failed banks with assets between $1 billion and $10 

billion represented 5% of total assets held by failed banks. Assets held at each of the three failed 

banks with assets greater than $10 billion (Washington Mutual Bank (“WaMu”), IndyMac Bank 

(“IndyMac”), and Downey Savings and Loan (“Downey”)) ranged from 3% to 83% of total 

assets held by failed banks. Given that most of the assets were held by these three banks, 

analysis performed for this group is presented individually. Additionally, more detailed analysis 

was performed to understand the causes of any significant fair value losses recognized by any of 

the failed banks. 

To analyze the impact of fair value accounting on the failed banks, the Staff reviewed publiclyavailable quarterly financial data for each of the 22 failed banks for periods during 2006, 2007, 

and 2008.138 The Staff used quarterly financial data to assess the extent to which the failed banks 

applied fair value accounting on a recurring and non-recurring basis and whether fair value 

 

134 For a bank that is not a member of the Federal Reserve System and instead regulated by the banking laws in the 

state in which it is chartered, the primary bank regulator is the state bank regulator. For these banks the primary 

federal regulator for purposes of PCA is the FDIC. 

135 12 U.S.C. 1831o et seq.

136 To the extent those banks met the relevant sample criteria, they were, however, included in Section II of this 

study. 

137 In order to timely incorporate data for each failed bank, banks that failed after December 1, 2008 were not 

included in the analysis performed. As of December 29, 2008, three additional banks had failed: First Georgia 

Community Bank (December 5, 2008), Haven Trust Bank (December 12, 2008), and Sanderson State Bank 

(December 12, 2008). 

138 The Federal Financial Institutions Examination Council (“FFIEC”) Central Data Repository Public Data 

Distribution (“CDR PDD”) website provides financial and structural information for FDIC-insured institutions. For 

institutions whose primary federal regulator is the FDIC, the Office of the Comptroller of the Currency (“OCC”) or 

the Federal Reserve, quarterly financial data are filed on Call Reports that are available on the FFIEC website. For 

thrifts regulated by the Office of Thrift Supervision (“OTS”), quarterly financial data are filed on Thrift Financial 

Reports (“TFRs”) that are available on the OTS website. 
99

accounting significantly reduced regulatory capital. In assessing the safety and soundness of the 

institutions they supervise, Agencies distinguish between equity as reported under U.S. GAAP 

and regulatory capital used to assess capital adequacy. In analyzing the impact of fair value 

accounting on regulatory capital, the Staff considered the fact that not all changes in fair value 

that affect equity also affect regulatory capital during the periods analyzed. The Staff also 

reviewed data provided in quarterly financial reports on credit losses and past due loans to assess 

the role of credit performance on bank failures. To gain insight into the causes of the bank 

failures, the Staff also reviewed public reports and press releases regarding the failed banks 

available on the Agency websites. 

Seven of the 22 failed banks were owned by public companies that filed financial reports with 

the SEC. While the study methodology in Section II excluded non-public financial institutions, 

for purposes of this portion of the study, all 22 banks were analyzed. For those banks that filed 

periodic reports with the SEC, the Staff analyzed those filings, particularly the MD&A sections 

of Forms 10-K and 10-Q, to understand how management described the factors affecting bank 

performance. Three of the public banks that failed were larger banks with assets greater than 

$10 billion that had active equity analyst coverage. For these three banks, the Staff also 

reviewed a sample of equity analyst reports and looked at changes in market share price for 

insights into the causes of these bank failures. 

B. Regulatory Framework Governing Bank Failures 

1. Capital Adequacy Guidelines 

The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) established 

the current PCA provisions. PCA is a framework of supervisory actions for insured depository 

institutions that are not adequately capitalized. The purpose of the PCA requirements “is to 

resolve the problems of insured depository institutions at the least possible long-term loss to the 

Deposit Insurance Fund.”139 The PCA framework includes mandatory minimum Agency actions 

that become increasingly severe as an institution falls within lower capital categories. In 

addition to the minimum requirements, the Agencies also have the authority to initiate additional 

discretionary actions, such as memorandums of understanding, cease-and-desist orders, and 

capital directives. 

As illustrated in Exhibit III.1, the PCA provisions establish five capital categories ranging from 

well capitalized to critically under capitalized and requires that the capital standards put in place 

by the Agencies include a leverage limit and a risk-based capital requirement. With the 

exception of minimum requirements for determining whether an institution is critically 

undercapitalized, the specific capital standards currently in place were determined by the 

Agencies. Each Agency applies the guidelines below to determine in which capital category an 

institution falls. 

 

139 12 U.S.C. 1381o(a)(1). 
100

Exhibit III.1: Capital Adequacy Guidelines 

Total RiskBased140Tier 1 / RiskBased141Tier 1 / 

Leverage142

Well Capitalized 10% or greater 6% or greater 5% or greater 

Adequately Capitalized 8% or greater 4% or greater 4% or greater* 

Undercapitalized Less than 8% Less than 4% Less than 4%* 

Significantly 

Undercapitalized Less than 6% Less than 3% Less than 3% 

Critically 

Undercapitalized 

Tangible equity to total assets that is equal to or less than 

2% 

* 3% for institutions with the highest rating under the CAMELS rating system 

In addition to setting the capital ratio requirements, the Agencies’ regulatory capital standards 

also provide instructions for deriving the numerators (Tier 1 and total risk-based capital) and the 

denominators (risk-based assets and average assets) used to calculate the capital ratios.143 Banks 

are required to calculate and report their capital levels as of each quarter end. Undercapitalized 

banks are subject to a number of mandatory requirements, including having to submit a capital 

restoration plan within 45 days. In addition to mandatory requirements, Agencies can also 

impose discretionary restrictions that are determined to be necessary to help resolve the problems 

at the bank at the least possible long-term cost to the FDIC. Significantly undercapitalized banks 

and undercapitalized banks that fail to submit and implement capital restoration plans are subject 

to additional restrictions. Critically undercapitalized banks are subject to the same restrictions as 

significantly undercapitalized banks along with a requirement that critically undercapitalized 

banks be placed in receivership or conservatorship within 90 days of becoming critically 

undercapitalized, unless the primary federal or state regulator and the FDIC agree that some 

other action would better achieve the purpose of PCA. 

The Agencies have the authority to appoint a receiver or conservator for a bank on grounds 

unrelated to whether it has become critically undercapitalized. In assessing the soundness of an 

institution, the Agencies employ a Uniform Financial Institutions Rating System,144 also referred 

 

140 The Total Risk-Based Capital ratio is calculated by dividing total risk-based capital by risk-weighted assets. 

Total Risk-Based Capital is a measure that starts with U.S. GAAP equity and includes adjustments to remove items 

such as unrealized gains (losses) on AFS debt securities and deduct disallowed goodwill and other disallowed 

intangible assets, but also includes items that for U.S. GAAP purposes are not accounted for as equity, such as 

qualified subordinated debt, redeemable preferred stock and certain allowances for loan and lease losses. Riskweighted assets are derived from a calculation that assigns risk weighting factors to assets reported in the U.S. 

GAAP balance sheet and to off-balance sheet exposures. 

141 The Tier 1 risk-based capital ratio is calculated by dividing Tier 1 capital by risk-weighted assets. Tier 1 capital 

is a measure that starts with U.S. GAAP equity and includes adjustments to remove items such as unrealized gains 

(losses) on AFS debt securities and deduct disallowed goodwill and other disallowed intangible assets. Items such 

as certain allowances for loan losses that are included in Total Risk-Based Capital are not included in Tier 1 capital. 

142 The leverage ratio is calculated by dividing Tier 1 capital by average assets which is adjusted for assets deducted 

from Tier 1 capital. 

143 See 12 CFR part 3 (national banks); 12 CFR part 208 (state member banks); 12 CFR part 325 (state nonmember 

banks); and 12 CFR part 567 (savings associations). 

144 See, FDIC, Uniform Financial Institutions Rating System. [62 FR 752 (January 6, 1997)] 
101

to as the “CAMELS” rating system, and assign a composite rating based on an evaluation and 

rating of six essential components of the bank’s financial condition and operations. These 

component factors address the adequacy of capital, the quality of assets, the capability of 

management, the quality and level of income, the adequacy of liquidity, and the sensitivity to 

market risk (including interest rates). Grounds on which a receiver or conservator may be 

appointed include, among others: the bank is in an unsafe and unsound condition to conduct 

business, the bank is likely to be unable to pay its obligations or meet its depositors’ demands, 

and the bank has incurred or is likely to incur losses that will deplete all or substantially all of its 

capital and there is no reasonable prospect for the bank to become adequately capitalized without 

federal assistance. State chartering authorities also may appoint a conservator or receiver for a 

bank under state law. 

 2. Reported Capital Status for 2008 Failed Banks 

Exhibit III.2 below shows basic descriptive information, including the last reported capital status, 

for each of the 22 banks that failed as of December 1, 2008. 

As more fully described in the remainder of this section, for most of the failed banks studied, the 

immediate cause of failure was the inability to become adequately capitalized. For some failed 

banks, the immediate cause of failure was the inability to meet depositors’ needs. Some failed 

banks that were closed due to liquidity also had inadequate capital, but others had adequate 

capital at the time of closure. Most notably, the largest bank to fail, WaMu, was well-capitalized 

according to the applicable capital adequacy standards at the time of failure. 
102

Exhibit III.2: Failed Banks 

Bank Name Location 

Primary 

Federal 

Regulator 

Date of 

Failure 

Total Assets 

(in U.S. 

Dollars)* 

Last Reported 

Capital Status 

Estima

Cost to 

Insura

Fund

1 Douglass National Bank Kansas City, MO OCC 1/25/2008 < $1 billion Significantly Undercapitalized $0.006 bil2 Hume Bank Hume, MO FDIC 3/07/2008 < $1 billion Well Capitalized No estima

provided 

3 ANB Financial Bentonville, AR OCC 5/09/2008 < $3 billion Critically Undercapitalized $0.214 bil4 First Integrity Bank Staples, MN OCC 5/30/2008 < $1 billion Critically Undercapitalized $0.002 bil5 IndyMac Bank Pasadena, CA OTS 7/11/2008 < $33 billion Significantly Undercapitalized $4 to $8 b6 First Heritage Bank Newport Beach, CA OCC 7/25/2008 < $1 billion Critically Undercapitalized ** 7 FN Bank of Nevada Reno, NV OCC 7/25/2008 < $4 billion Undercapitalized $0.862 bil8 First Priority Bank Bradenton, FL FDIC 8/01/2008 < $1 billion Critically Undercapitalized $0.072 bil9 Columbian Bank and Trust Topeka, KS FDIC 8/22/2008 < $1 billion Adequately Capitalized $0.06 billi

10 Integrity Bank Alpharetta, GA FDIC 8/29/2008 < $2 billion Undercapitalized $0.25 to $

billion 

11 Silver State Bank Henderson, NV FDIC 9/05/2008 < $3 billion Adequately Capitalized $0.45 to $

billion 

12 Ameribank Northfork, WV OTS 9/19/2008 < $1 billion Critically Undercapitalized $0.042 bil13 Washington Mutual Bank Henderson, NV OTS 9/25/2008 <$308 billion Well Capitalized $0 14 Main Street Bank Northville, MI FDIC 10/10/2008 < $1 billion Significantly Undercapitalized $0.033 to $0.039bill15 Meridian Bank Eldred, IL FDIC 10/10/2008 < $1 billion Critically Undercapitalized $0.013 to 

billion 

16 Alpha Bank & Trust Alpharetta, GA FDIC 10/24/2008 < $1 billion Critically Undercapitalized $0.158 bil
103

Bank Name Location 

Primary 

Federal 

Regulator 

Date of 

Failure 

Total Assets 

(in U.S. 

Dollars)* 

Last Reported 

Capital Status 

Estima

Cost to 

Insura

Fund

17 Freedom Bank Bradenton, FL FDIC 10/31/2008 < $1 billion Significantly Undercapitalized $0.08 to $

billion 

18 Franklin Bank Houston, TX FDIC 11/07/2008 <$6 billion Significantly Undercapitalized $1.4 to $1

billion 

19 Security Pacific Bank Los Angeles, CA FDIC 11/07/2008 < $1 billion Significantly Undercapitalized $0.21 billi20 The Community Bank Loganville, GA FDIC 11/21/2008 < $1 billion Significantly Undercapitalized $0.2 to $0

billion 

21 Downey Savings and Loan Newport Beach, CA OTS 11/21/2008 < $13 billion Well Capitalized $1.4 billio22 PFF Bank and Trust Pomona, CA OTS 11/21/2008 <$4 billion Undercapitalized $0.7 billio

* As reported in the press release issued by the FDIC at the time of the institution’s closure. ** FDIC has estimated a combined cost to the FDIC insurance fund of $0.862 billion for First Heritage Bank of Newport Beach and FN Bank of Nevada. 
104

C. How Fair Value Accounting Affects Reporting under U.S. GAAP for Banks 

This subsection first summarizes how and the extent to which fair value accounting affects banks 

and then describes empirically how the failed banks accounted for their assets and liabilities. 

As noted in Section II.B, the majority of a bank’s assets and liabilities overall are typically not 

accounted for at fair value with changes in fair value recognized in net income. For most banks, 

HFI loans represented the most significant asset type held.145 As more fully described in Section 

I.D, HFI loans are not generally accounted for at fair value, but instead are generally accounted 

for at amortized cost with recognition of incurred credit losses. Incurred credit losses are 

recognized when it becomes probable that the borrower will not make all contractual payments 

when due.146 Changes in the fair value of HFI loans usually do not affect a bank’s U.S. GAAP 

reported balance sheet or income statement. 

One instance in which the measurement of credit loss can be affected by fair value measurements 

is problem loans for which collection of the loan is expected to come solely from the underlying 

collateral. Measurement of credit losses for these types of loans is based on the fair value of the 

supporting collateral.147 Similarly, accounting for foreclosed property held by a bank is based on 

the fair value of the property.148 Most banks also tend to hold portfolios of securities that are 

classified as AFS under U.S. GAAP.149 As more fully described in Section I.D, unrealized fair 

value losses for AFS securities are only recognized in income when the decline is other-thantemporary. 

As indicated by the findings in Section II, typically, the more complex a bank’s activities, the 

more extensive role fair value plays in the bank’s accounting. For example, banks that originate 

and purchase loans to be sold generally report those activities on a fair value basis. Banks that 

historically originated and sold a high volume of loans are likely to have significant HFS loans 

on their balance sheet. HFS loans are generally accounted for either at the lower-of-cost-or-fairvalue or at fair value with all changes in fair value recognized in income.150 Banks participating 

in the securitization business are also likely to hold MSRs in sold loans. These servicing rights 

 

145 According to the FDIC-published third quarter 2008 “Quarterly Banking Profile,” for all FDIC-insured 

institutions, net loans and leases represented 58% of reported bank assets as of September 30, 2008. (available at 

http://www2.fdic.gov/qbp/index.asp) 

146 See SFAS No. 5, paragraph 23. 

147 SFAS No. 114 (paragraph 13) only requires measurement of impairment to be based on the fair value of the 

collateral when foreclosure is probable, but the Agencies require impairment of any collateral-dependent loans to be 

measured using the fair value of collateral method. A loan is collateral-dependent if repayment of the loan is 

expected to be provided solely by the underlying collateral. 

148 SFAS No. 144 (paragraph 34) requires long-lived assets classified as held-for-sale to be measured at the lower of 

their carrying amount or fair value less cost to sell. 

149 According to the FDIC-published third quarter 2008 “Quarterly Banking Profile,” all securities, including AFS 

and HTM securities, but excluding trading securities, held by FDIC-insured institutions represented 15% of reported 

bank assets as of September 30, 2008. 

150 SFAS No. 159 (paragraph 7) provides banks with the option of electing fair value accounting for loans. SFAS 

No. 65 (paragraph 4) requires that HFS mortgage loans for which the FVO has not been elected be accounted for at 

the lower-of-cost-or-fair-value. 
105

are non-financial assets that are generally accounted for at the lower-of-cost-or-fair-value or at 

fair value with changes in fair value recognized in income.151 Banks that are involved in the 

securitization of loans are also more likely to engage in significant hedging activities. This will 

likely result in the bank holding more trading securities and derivative contracts entered into so 

that their fair value changes offset other exposures, such as HFS loans and MSRs that are also 

accounted for at fair value. As more fully described in Section I.D, trading securities and 

derivative contracts are accounted for at fair value with changes in fair value recognized in 

income. 

1. Aggregate Failed Banks < $1 Billion of Total Assets152

Exhibit III.3 shows that for the 12 failed banks with total assets of less than $1 billion, loans 

accounted for at amortized cost (historical cost accounting) have continuously represented more 

than 80% of bank assets.153 Exhibit III.4 shows that these banks had no assets accounted for on a 

recurring basis at fair value with changes in fair value recognized in income. These banks had 

no reported trading assets or liabilities, non-trading financial assets, MSRs for which FVO was 

elected, or derivatives. As illustrated in Exhibit III.5, investment securities accounted for as 

either AFS or HTM that are recognized at fair value through income if declines in the fair value 

are other-than-temporary represented 5% of assets held. Exhibit III.6 shows that these banks 

also had very little exposure to assets that are written down to the lower-of-cost-or-fair-value, 

because they historically held no significant portfolios of HFS loans and, until the most recent 

periods, had very little amounts of foreclosed property (listed in the exhibit as “other real estate” 

owned). 

 

151 SFAS No. 140 (paragraph 13A), as amended by SFAS No. 156, provides banks with the option to elect fair value 

accounting for servicing rights, or alternatively use an amortization method that requires servicing rights to be 

written down for declines in fair value. 

152 For each grouping of failed banks by size, data are not included for individual failed banks for period ends for 

which the bank did not report because their failure pre-dated reporting requirements. 

153 There were 13 failed banks with total assets less than $1 billion included in this portion of the study, but one of 

those failed banks, First Heritage Bank, has been grouped in the data provided for failed banks with total assets 

between $1 billion and $10 billion. First Heritage Bank has been grouped with the First National Bank of Nevada 

because both were subsidiaries of the same holding company, First National Bank Holding Company. 
106

Exhibit III.3: Loans Accounted for on an Amortized-Cost Basis154

 Total Loans on a Percent of 

Period Ended Assets* Cost Basis** Total Assets 

 (U.S. dollars in thousands) 

June 30, 2008 $3,134,617 $2,598,764 83% 

March 31, 2008 3,229,290 2,689,863 83% 

December 31, 2007 3,290,597 2,761,350 84% 

December 31, 2006 2,677,288 2,259,851 84% 

* For all tables of this type: (1) for banks filing Call Reports, total assets as reported in Schedule RC and (2) for banks filing TFRs, total assets as 

reported in Schedule SC. 

** For all tables of this type: (1) for banks filing Call Reports, loans accounted for on an amortized-cost basis are based on total loans and leases, 

net of unearned income reported in Schedule RC-C, less HFS loans reported in Schedule RC, and less any loans accounted for at fair value as 

reported in Schedule RC-Q and (2) for banks filing TFRs, loans accounted for on an amortized-cost basis are based on total net mortgage and 

non-mortgage loans less allowance for loan and lease losses and accrued interest receivable as reported in Schedule SC, less HFS assets reported 

in Schedule SI, and less any loans accounted for at fair value. 

Exhibit III.4: Assets and Liabilities Accounted for at Fair Value on a Recurring Basis through 

Income 

Period Ended 

Trading 

Assets* 

Non-Trading 

Financial 

Assets** 

NonFinancial 

Assets*** Liabilities#

(As a percent of total assets) 

June 30, 2008 0% 0% 0% 0% 

March 31, 2008 0% 0% 0% 0% 

December 31, 2007 0% 0% 0% 0% 

December 31, 2006 0% 0% 0% 0% 

* For all tables of this type: (1) for banks filing Call Reports, trading assets as reported in Schedule RC and (2) for banks filing TFRs, financial 

assets held for trading purposes as reported in Schedule SI. 

** For all tables of this type: (1) for banks filing Call Reports, non-trading financial assets accounting for at fair value includes non-trading 

financial assets reported in Schedule RC-Q and non-trading derivative contracts as reported in Schedule RC-F155 and (2) for banks filing TFRs, 

non-trading financial assets accounted for at fair value includes financial assets carried at fair value through income, less financial assets held for 

trading purposes as reported in Schedule SI. 

*** For all tables of this type, if FVO for MSRs was elected under SFAS No. 156: (1) for banks filing Call Reports, non-financial assets 

accounted for at fair value consist of MSRs as reported in Schedule RC-Q and (2) for banks filing TFRs, non-financial assets accounted for at fair 

value consist of MSRs as reported in Schedule SC. 

# For all tables of this type: (1) for banks filing Call Reports, liabilities at fair value includes trading liabilities as reported in Schedule RC, nontrading derivative liabilities as reported in Schedule RC-G and non-trading liabilities included in Schedule RC-Q and (2) for banks filing TFRs, 

financial liabilities at fair value as reported in Schedule SI. 

 

154 Other types of assets that banks account for using an amortized-cost basis include cash; property, plant and 

equipment in use; prepaid expenses; and accrued interest receivable. 

155 Although all non-trading derivatives as reported in the Call Report are presented, a portion of non-trading 

derivatives may be accounted for as cash flow hedges, and therefore all changes in fair value would not be 

immediately reported in income. 
107

Exhibit III.5: Investment Securities (Fair Value Losses Recognized Only When Impaired)156

Period Ended AFS* HTM** AFS HTM 

(U.S. dollars in thousands) (Percent of total assets) 

June 30, 2008 $148,295 $2,990 5% 0% 

March 31, 2008 167,053 3,127 5% 0% 

December 31, 2007 181,142 3,164 6% 0% 

December 31, 2006 129,922 3,193 5% 0% 

* For all tables of this type: (1) for banks filing Call Reports, AFS securities as reported in Schedule RC and (2) 

for banks filing TFRs, AFS securities as reported in Schedule SI. 

** For all tables of this type: (1) for banks filing Call Reports, HTM securities as reported in Schedule RC and (2) 

for banks filing TFRs, HTM securities is based on total securities as reported in Schedule SC, less trading and 

AFS securities as reported in Schedule SI. 

Exhibit III.6: Assets Accounted for at the Lower-of-Cost-or-Fair-Value157

Period Ended Loans HFS* 

Other Real 

Estate** Loans HFS 

Other Real 

Estate 

(U.S. dollars in thousands) (Percent of total assets) 

June 30, 2008 $1,320 $90,062 0% 3% 

March 31, 2008 2,157 65,375 0% 2% 

December 31, 2007 3,059 53,333 0% 2% 

December 31, 2006 4,965 4,758 0% 0% 

* For all tables of this type: (1) for banks filing Call Reports, HFS loans and leases as reported in Schedule RC and (2) for banks filing TFRs, 

loans and HFS assets as reported in Schedule SI. 

** For all tables of this type: (1) for banks filing Call Reports, other real estate owned as reported in Schedule RC and (2) for banks filing TFRs, 

total repossessed assets as reported in Schedule SC. 

2. Aggregate Failed Banks > $1 Billion, but < $10 Billion of Total 

Assets158

As illustrated in Exhibit III.7, loans accounted for based on amortized cost also made up the 

majority of the assets held by the failed banks with assets greater than $1 billion, but less than 

$10 billion. Although these banks had slightly more assets accounted for on a recurring basis at 

fair value, as illustrated in Exhibit III.8, recurring fair value accounting made up a relatively 

insignificant portion of these banks’ balance sheets. As illustrated in Exhibit III.9, investment 

securities accounted for as either AFS or HTM that are recognized at fair value through income 

 

156 Tables for investment securities for which fair value losses are recognized when impaired do not include equity 

securities that do not have readily determinable fair values. These securities are not accounted for in accordance 

with SFAS No. 115 as either AFS or HTM and are reported in the Call Report as “other assets.” Other assets are 

items that typically individually are not significant to the balance sheet. 

157 Tables for assets accounted for at the lower-of-cost-or-fair-value do not include intangible assets which, as more 

fully discussed in Section I.D, are subject to impairment tests that are based on fair value measurements once certain 

triggers are met. 

158 Because the First National Bank of Arizona was merged into First National Bank of Nevada and Choice Bank 

was merged into Silver State Bank as of June 30, 2008, information for these banks is included for all periods 

presented. 
108

if declines in the fair value are other-than-temporary represented 6% of assets held. As 

illustrated in Exhibit III.10, prior to the 2007 tightening in the secondary market for non-agency 

mortgage loans, HFS loans made up 10% of the balance sheets of these banks. The majority of 

the HFS loans reported as of December 31, 2006 for this grouping were held at the First National 

Bank of Arizona, which merged into the First National Bank of Nevada just prior to the bank’s 

failure in 2008. The significant decease during 2007 in HFS loans was due to the decision made 

by First National Bank of Arizona during 2007 to wind down its national wholesale mortgage 

business.159 

Exhibit III.7: Loans Accounted for on an Amortized-Cost Basis 

 Total Loans on a Percent of 

Period Ended Assets* Cost Basis** Total Assets 

(U.S. dollars in thousands)

June 30, 2008 $ 16,406,725 $ 12,864,533 78% 

March 31, 2008 19,666,923 15,398,023 78% 

December 31, 2007 19,652,563 15,685,922 80% 

December 31, 2006 18,731,349 14,368,103 77% 

Exhibit III.8: Assets and Liabilities Accounted for at Fair Value on a Recurring Basis through 

Income 

Period Ended 

Trading 

Assets* 

Non-Trading 

Financial 

Assets** 

NonFinancial 

Assets*** Liabilities#

(As a percent of total assets) 

June 30, 2008 0% 1% 0% 0% 

March 31, 2008 0% 1% 0% 0% 

December 31, 2007 0% 0% 0% 0% 

December 31, 2006 0% 0% 0% 0% 

Exhibit III.9: Investment Securities (Fair Value Losses Recognized Only When Impaired) 

Period Ended AFS* HTM** AFS HTM 

(U.S. dollars in thousands) (Percent of total assets) 

June 30, 2008 $634,383 $340,354 4% 2% 

March 31, 2008 687,064 355,636 3% 2% 

December 31, 2007 909,440 346,709 5% 2% 

December 31, 2006 856,319 14,092 5% 0% 

 

159 See 2007 Annual Report for First National Bank Holding Company, The President’s Message, page 3. 
109

Exhibit III.10: Assets Accounted for at the Lower-of-Cost-or-Fair-Value 

 Other Other 

Period Ended Loans HFS* Real Estate** Loans HFS Real Estate 

(U.S. dollars in thousands) (Percent of total assets) 

June 30, 2008 $195,535 $168,170 1% 1% 

March 31, 2008 231,392 123,658 1% 1% 

December 31, 2007 327,299 86,524 2% 0% 

December 31, 2006 1,954,882 31,862 10% 0% 

3. Failed Banks > $10 Billion of Total Assets 

a. Washington Mutual 

WaMu, with assets in excess of $300 billion, was much larger than the other failed banks. 

However, like the smaller failed banks, Exhibit III.11 indicates that loans accounted for on an 

amortized-cost basis made up a majority of WaMu’s assets. Because its activities were not as 

concentrated in the originate-to-distribute model, the portion of WaMu’s balance sheet accounted 

for at fair value was significantly smaller than large banks in general. Exhibit III.12 shows that, 

in total, WaMu had less then 5% of its assets accounted for on a recurring basis at fair value with 

changes in fair value through income. This is in contrast to the analysis in Section II.B, which 

demonstrated that 22% of bank assets were accounted for at fair value through income. Exhibit 

III.12 illustrates that MSRs made up approximately 50% of the assets that WaMu accounted for 

at fair value through income. In 2006, WaMu elected to early adopt the FVO provided in SFAS 

No. 156 to its MSRs because it actively hedged the fair value of these assets. As illustrated in 

Exhibit III.13, AFS investment securities represented 8% of WaMu’s assets. Exhibit III.14 

shows that like failed banks with assets between $1 billion and $10 billion, the percentage of 

WaMu’s assets made up of HFS loans significantly decreased during 2007. In WaMu’s 2007 

Form 10-K, it disclosed that: 

Due to the illiquid market, residential mortgage loans designated as held for sale at 

December 31, 2007 were largely limited to conforming loans eligible for purchase by the 

housing government-sponsored enterprises. The December 31, 2006 balance of loans 

held for sale included approximately $17.5 billion of medium-term adjustable-rate home 

loans which were transferred during the fourth quarter of 2006 from loans held in 

portfolio to loans held for sale. These loans were subsequently sold during the first 

quarter of 2007. In addition, as a result of the severe contraction in secondary market 

liquidity, the Company transferred approximately $17 billion of real estate loans to its 

loan portfolio during the third quarter of 2007, which represented substantially all of the 

Company’s nonconforming loans that had been designated as held for sale prior to the 

market disruption. 
110

Exhibit III.11: Loans Accounted for on an Amortized-Cost Basis 

 Total Loans on a Percent of 

Period Ended Assets* Cost Basis** Total Assets 

(U.S. dollars in thousands) 

June 30, 2008 $307,021,614 $239,716,859 78% 

March 31, 2008 317,823,952 242,870,154 76% 

December 31, 2007 325,808,657 245,851,488 75% 

December 31, 2006 345,610,758 224,940,422 65% 

Exhibit III.12: Assets and Liabilities Accounted for at Fair Value on a Recurring Basis through 

Income 

Period Ended 

Trading 

Assets* 

NonTrading 

Financial 

Assets** 

NonFinancial 

Assets*** Liabilities#

(As a percent of total assets)

June 30, 2008 1% 1% 2% 0% 

March 31, 2008 1% 1% 2% 0% 

December 31, 2007 1% 1% 2% 0% 

December 31, 2006 1% Not Available^ 2% Not Available^

^The TFR did not collect information on non-trading assets accounted for at fair value or liabilities accounted for at fair value as of December 31, 

2006. 

Exhibit III.13: Investment Securities (Fair Value Losses Recognized Only When Impaired) 

Period Ended AFS* HTM** AFS HTM 

(U.S. dollars in thousands) (Percent of total assets) 

June 30, 2008 $24,027,524 $0 8% 0% 

March 31, 2008 23,314,000 0 7% 0% 

December 31, 2007 27,260,612 0 8% 0% 

December 31, 2006 24,876,648 0 7% 0% 

Exhibit III.14: Assets Accounted for at the Lower-of-Cost-or-Fair-Value 

Period Ended Loans HFS* 

Other 

Real Estate** Loans HFS 

Other 

Real Estate 

 (U.S. dollars in thousands) (Percent of total assets) 

June 30, 2008 $1,878,668 $1,531,807 1% 0% 

March 31, 2008 4,982,299 1,381,066 2% 0% 

December 31, 2007 5,428,396 1,015,127 2% 0% 

December 31, 2006 45,033,198 578,385 13% 0% 
111

b. IndyMac 

IndyMac, which had assets in excess of $30 billion and specialized in the securitization and 

servicing of non-agency loans, demonstrated a contrast to the other failed banks. For example, 

as shown in Exhibit III.15, loans accounted for at amortized cost made up a significant portion of 

its balance sheet, but a much smaller portion when compared to the other failed banks. IndyMac 

retained a significant portfolio of mortgage-backed securities and residual interests that were 

created by its private-label securitization activities. Many of these interests were classified as 

trading assets and therefore were accounted for at fair value with changes in fair value 

recognized in income. Due to changing market conditions for mortgage-backed securities, 

during 2007 IndyMac retained significantly more of the securities generated by its securitization 

activities. These interests included non-investment grade securities (rated below BBB) that have 

concentrated credit risk, as they typically absorb a greater amount of credit losses before such 

losses affect senior or other investment grade securities, as well as residual interests that 

represent the first loss position and are not typically rated by the nationally-recognized rating 

agencies. In IndyMac’s 2007 Form 10-K, it disclosed that: 

We consider certain of our investment grade securities to be economic hedges of our noninvestment grade securities and residuals. We classify these investment grade securities 

as trading securities in order to reflect changes in their fair values in our current results. 

Residuals are generally classified as trading securities so the accounting for these 

securities will mirror the economic hedging activities. All other MBS, including a 

portion of our non-investment grade securities, are classified as available for sale. 

In addition to the significant portfolio of securities accounted for at fair value, in 2006 IndyMac 

elected to account for its MSRs at fair value because it actively hedged their fair value with 

derivatives and trading securities accounted for at fair value. Additionally, in 2008, IndyMac 

elected to account for its HFS mortgage loans also on a recurring basis at fair value with all 

changes in fair value recognized in income. Exhibit III.16 shows that as of March 31, 2008, 

financial assets accounted for at fair value on a recurring basis through income made up 13% of 

IndyMac’s assets, with MSRs accounted for at fair value through income making up an 

additional 8% of assets. Exhibit III.17 shows that IndyMac also had a significant amount of 

investment securities accounted for as AFS. Exhibit III.18 shows that during 2007, the amount 

of assets accounted for at the lower-of-cost-or-fair value declined from 33% of assets to 13% of 

assets, due to a significant decline in HFS loans.
112

Exhibit III.15: Loans Accounted for on an Amortized-Cost Basis 

 Total Loans on a Percent of 

Period Ended Assets* Cost Basis** Total Assets

 (U.S. dollars in thousands) 

June 30, 2008 $30,698,512 Not Available^ Not Available^ 

March 31, 2008 32,010,816 $16,616,326 52% 

December 31, 2007 32,514,479 16,413,389 50% 

December 31, 2006 28,740,902 10,187,305 35% 

^IndyMac’s TFR was partially filed for the period ended June 30, 2008. Schedule SI was not filled out, accordingly the information necessary to 

calculate loans accounted for on a cost basis was not available. 

Exhibit III.16: Assets and Liabilities Accounted for at Fair Value on a Recurring Basis through 

Income 

Period Ended Trading Assets* 

Non-Trading 

Financial Assets** 

Non-Financial 

Assets*** Liabilities#

 (As a percent of total assets)

June 30, 2008 Not Available^ Not Available^ 8% Not Available^

March 31, 2008 3% 10% 8% (1)% 

December 31, 2007 4% 3% 8% (2)% 

December 31, 2006 2% Not Available^^ 6% Not Available^^

^ IndyMac’s TFR was partially filed for the period ended June 30, 2008. Schedule SI was not filled out, accordingly the information necessary to 

calculate trading assets and non-trading financial assets and liabilities accounted for at fair value was not available. 

^^ The TFR did not collect information on non-trading assets accounted for at fair value or liabilities accounted for at fair value as of December 

31, 2006. 

Exhibit III.17: Investment Securities (Fair Value Losses Recognized Only When Impaired) 

Period Ended AFS* HTM** AFS HTM 

 (U.S. dollars in thousands) (Percent of total assets) 

June 30, 2008 Not Available^ Not Available^ Not Available^ Not Available^

March 31, 2008 $5,311,510 $0 17% 0% 

December 31, 2007 5,892,727 0 18% 0% 

December 31, 2006 4,183,629 0 15% 0% 

^ IndyMac’s TFR was partially filed for the period ended June 30, 2008. Schedule SI was not filled out; accordingly, the information necessary 

to calculate AFS and HTM securities was not available. 
113

Exhibit III.18: Assets Accounted for at the Lower-of-Cost-or-Fair-Value 

Period Ended Loans HFS* 

Other Real 

Estate** Loans HFS 

Other Real 

Estate 

(U.S. dollars in thousands) (% of total asset) 

June 30, 2008 Not Available^ $321,902 Not Available^ 1% 

March 31, 2008 $ 914,150 257,182 3% 1% 

December 31, 2007 3,777,181 196,049 12% 1% 

December 31, 2006 9,468,246 21,638 33% 0% 

^ IndyMac’s TFR was partially filed for the period ended June 30, 2008. Schedule SI was not filled out; accordingly, the information necessary 

to calculate loans HFS was not available. 

c. Downey Savings and Loan 

As illustrated in Exhibit III.19, Downey, a bank with assets of more than $10 billion, was similar 

to the failed banks with less than $1 billion of assets in that loans accounted for based on 

amortized cost made up the vast majority of the bank’s assets. Like smaller banks, Downey did 

not have any significant balance of assets or liabilities accounted for using recurring fair value 

accounting through income (Exhibit III.20) or at the lower-of-cost-or-fair-value (Exhibit III.22), 

but did have significant balances of investment securities accounted for as AFS that are 

recognized at fair value if declines in the fair value are other-than-temporary (Exhibit III.21). 

Exhibit III.19: Loans Accounted for on an Amortized-Cost Basis 

 Total Loans on a Percent of 

Period Ended Assets* Cost Basis** Total Assets

 (U.S. dollars in thousands) 

 June 30, 2008 $12,630,056 $11,203,919 89% 

 March 31, 2008 13,130,348 11,083,031 84% 

 December 31, 2007 13,408,965 11,341,267 85% 

 December 31, 2006 16,208,730 13,870,461 86% 

Exhibit III.20: Assets and Liabilities Accounted for at Fair Value on a Recurring Basis through 

Income

 Non-Trading Non-Financial 

Period Ended Trading Assets* Financial Assets** Assets*** Liabilities#

(As a percent of total assets)

June 30, 2008 0% 0% 0% 0% 

March 31, 2008 0% 0% 0% 0% 

December 31, 2007 0% 0% 0% 0% 

December 31, 2006 0% Not Available^ 0% Not Available^

^The TFR did not collect information on non-trading assets accounted for at fair value or liabilities accounted for at fair value as of December 31, 

2006. 
114

Exhibit III.21: Investment Securities (Fair Value Losses Recognized Only When Impaired) 

Period Ended AFS* HTM** AFS HTM 

 (U.S. dollars in thousands) (Percent of total assets)

 June 30, 2008 $998,563 $0 8% 0% 

 March 31, 2008 1,603,209 0 12% 0% 

 December 31, 2007 1,549,990 0 12% 0% 

 December 31, 2006 1,433,426 2 9% 0% 

Exhibit III.22: Assets Accounted for at the Lower-of-Cost-or-Fair-Value 

 Other Other 

Period Ended Loans HFS* Real Estate** Loans HFS Real Estate

 (U.S. dollars in thousands) (Percent of total assets)

June 30, 2008 $85,558 $298,930 1% 2% 

March 31, 2008 109,253 229,299 1% 2% 

December 31, 2007 103,384 155,789 1% 1% 

December 31, 2006 363,215 35,945 2% 0% 

D. Interaction Between Regulatory Capital and U.S. GAAP 

As noted in Section I, the objective of financial reporting is to provide information useful to 

investors and creditors in their decision-making processes. The primary objective of prudential 

oversight is to foster safety and soundness and financial stability. For prudential oversight 

purposes, regulatory capital requirements for banks in the U.S. start with financial information 

provided in accordance with U.S. GAAP. There are instances in which the Agencies have 

determined that adjustments should be made to U.S. GAAP accounting for regulatory capital 

purposes, thereby reflecting the important differences between the objectives of U.S. GAAP 

reporting and the objectives of regulatory capital requirements. These adjustments are intended 

to reflect the solvency and safety and soundness of the banks on an ongoing basis. Consistent 

with the safety and soundness objective, losses on assets that are reflected in income and retained 

earnings in accordance with U.S. GAAP are generally recognized in regulatory capital. 

Section 121 of FDICIA requires that the accounting principles used in the reports and statements 

filed with the Agencies by insured depository institutions be no less stringent than U.S. 

GAAP.160 Consistent with the requirements of FDICIA, the instructions for preparing balance 

sheet and income statement reports filed with the Agencies are no less stringent than the 

requirements of U.S. GAAP. 

However, while equity, as presented under U.S. GAAP, is the starting point for the Agencies’ 

regulatory capital calculations, the Agencies’ regulatory capital standards and their instructions 

for calculating regulatory capital include several adjustments from U.S. GAAP-based equity. 

 

160 See 12 U.S.C. 1831n. 
115

For example, although unrealized gains and losses for AFS debt securities are included in U.S. 

GAAP-based equity (as part of accumulated OCI), these unrealized gains and losses generally do 

not impact regulatory capital. Losses that are realized by a bank, either by sale of the debt 

security or determination that the decline in the fair value of the debt security is other-thantemporary, are reflected in regulatory capital. In 1995, the OTS, as well as the other Agencies, 

issued a final rule to exclude unrealized gains and losses for AFS debt securities recognized 

under SFAS No. 115 from regulatory capital. In its final rule, the OTS stated: 

After considering all the comments received, the OTS, in consultation with the other 

Agencies, has decided not to adopt its proposal to include the SFAS No. 115 equity 

component in computing regulatory capital. ...Based on the comment letters received, the 

OTS determined that adoption of the proposal could potentially have an inappropriate 

impact on associations' regulatory capital and result in an inaccurate picture of their 

capital positions. For example, fluctuations in interest rates could cause temporary 

changes in regulatory capital levels, which in turn could trigger more permanent 

regulatory intervention and inappropriately affect industry profitability. ...The OTS 

considered the comments received regarding FDICIA’s requirement that regulatory 

accounting policy be no less stringent than GAAP. Section 121 of FDICIA requires that 

policies applicable to reports and statements filed with the Federal banking agencies 

generally conform to GAAP. The section, however, does not require the calculation of 

an institution's regulatory capital or the components of regulatory capital to conform to 

GAAP, and the legislative history of the section indicates that was not necessarily the 

intent of Congress.161

In addition to making adjustments to exclude from regulatory capital certain amounts reported 

under U.S. GAAP in accumulated OCI, the regulatory calculation of capital also includes 

adjustments to certain assets that are recognized and included in equity under U.S. GAAP.162 

For example, goodwill163 is deducted from regulatory capital and the inclusion in regulatory 

capital of certain servicing rights recognized as assets under U.S. GAAP is limited. As a result, 

fair value measurements that adjust the carrying amount of items excluded from regulatory 

capital, while reducing U.S. GAAP-based equity, may not have an impact on regulatory capital. 

In certain circumstances, the regulatory calculation of capital also includes items not reported in 

equity under U.S. GAAP. In 2005, the Federal Reserve issued a final rule addressing the 

definition of regulatory capital in which it stated: 

 

161 OTS, OTS Release No. 95-151 (August 3, 1995), Regulatory Capital: Common Stockholders’ Equity. [60 FR 

42025 (August 15, 1995)] 

162 See “Instructions for Preparation of Consolidated Reports of Condition and Income (FFIEC 031 and 041),” last 

updated June 2008 as provided on the FFIEC website, for a description of the assets reported under U.S. GAAP that 

are not eligible to be included in Schedule RC-R – Regulatory Capital. (available at 

http://www.ffiec.gov/PDF/FFIEC_forms/FFIEC031_041_200806_i.pdf) 

163 On September 30, 2008, the Agencies jointly issued a notice of proposed rulemaking seeking comment on 

whether to allow goodwill, which must be deducted from Tier 1 capital, to be reduced by the amount of any 

associated deferred tax liability. See, e.g., Federal Reserve System, Joint Notice of Proposed Rulemaking No. R1329 (September 30, 2008), Minimum Capital Ratios; Capital Adequacy Guidelines; Capital Maintenance; Capital; 

Deduction of Goodwill Net of Associated Deferred Tax Liability. [73 FR 190 (September 30, 2008)] 
116

A change in the GAAP accounting for a capital instrument does not necessarily change 

the regulatory capital treatment of that instrument. Although GAAP informs the 

definition of regulatory capital, the [Federal Reserve] is not bound to use GAAP 

accounting concepts in its definition of [T]ier 1 or [T]ier 2 capital because regulatory 

capital requirements are regulatory constructs designed to ensure the safety and 

soundness of banking organizations, not accounting designations established to ensure 

the transparency of financial statements. In this regard, the definition of [T]ier 1 capital 

since the [Federal Reserve] adopted its risk-based capital rule in 1989 has differed from 

GAAP equity in a number of ways. The [Federal Reserve] has determined that these 

differences are consistent with its responsibility for ensuring the soundness of the capital 

bases of banking organizations under its supervision. These differences are not 

differences between regulatory reporting and GAAP accounting requirements, but rather 

are differences only between the definition of equity for purposes of GAAP and the 

definition of [T]ier 1 capital for purposes of the Board’s regulatory capital requirements 

for banking organizations.164

In 2006 and 2007, with the issuance of U.S. GAAP standards that allowed banks to elect fair 

value accounting for their own liabilities, the Agencies considered, from a supervisory 

perspective, whether it is prudent for all changes in the fair value of liabilities to be included in 

regulatory capital. The quarterly call report supplemental instructions state: 

The agencies are considering the regulatory capital implications of the use of a fair value 

option, including the fair value option in FASB Statement No. 155 on certain hybrid 

financial instruments (FAS 155) and FASB Statement No. 156 on servicing assets and 

liabilities (FAS 156). Except as discussed below, changes in the fair value of assets and 

liabilities to which a fair value option is applied that are recognized in earnings should be 

reflected in Tier 1 capital, pending further guidance from the agencies. For a liability to 

which a fair value option is applied, banks should consider the effect of a change in their 

own creditworthiness on the fair value of the liability. The agencies have determined that 

banks should exclude from Tier 1 capital the cumulative change in the fair value of 

liabilities accounted for under a fair value option that is included in retained earnings 

(Schedule RC, item 26.a) and is attributable to changes in the bank’s own 

creditworthiness.165 

This adjustment to exclude from capital certain fair value changes recognized in equity addresses 

the Agencies concern that a bank in a deteriorating credit condition might recognize increases in 

regulatory capital as a result of unrealized fair value gains caused by declines in the bank’s own 

creditworthiness. 

 

164 Federal Reserve System, Final Rule No. R-1193 (March 10, 2005), Risk-Based Capital Standards: Trust 

Preferred Securities and the Definition of Capital. [70 FR 11827 (March 10, 2005)] 

165 FFIEC, Reporting Forms - FFIEC 031 Consolidated Reports of Condition and Income for a Bank with Domestic 

and Foreign Offices, Supplemental Instructions – September 2008. (available at 

http://www.ffiec.gov/PDF/FFIEC_forms/FFIEC031_041_suppinst_200809.pdf)
117

More generally – and not specific to the safety and soundness objective of prudential 

oversight – some banking regulators have stated that while fair value accounting for 

financial reporting may be useful,166 it is not without its challenges. In a comment letter to 

the IASB addressing the role of fair value accounting for financial instruments (dated 

September 19, 2008), the Basel Committee on Banking Supervision indicated 

...greater use of fair value might be an improvement in financial reporting if: (i) the 

conceptual and practical issues associated with fair value are resolved, (ii) active 

markets develop for major aspects of banking book positions, (iii) bank risk 

management evolves to rely on fair value measurements, and (iv) a broad range of 

users of financial statements, including depositors and other creditors of banks, find 

fair value to be the best measure in the primary financial statements. [Our] 

assessment is that currently, although some progress has been made towards the 

latter two criteria, primarily in the context of larger banks in developed nations, these 

four conditions have not been met.167

E. Analysis of Causes of Declines in Failed Bank Capital 

The Staff reviewed information provided in each of the failed banks’ income statements to 

identify income statement items that significantly reduced each bank’s Tier 1 capital. The Staff 

also gathered data on the extent to which recurring and non-recurring fair value measurements 

were recognized in income, thereby impacting Tier 1 capital.168 Presenting income statement 

data consistently for all of the failed banks is difficult because the Call Report and the Thrift 

Financial Report categorize and group income statement items in different formats. For 

example, in the Call Report, net realized gains and losses on AFS securities include gains and 

losses recognized upon sale, as well as impairment losses. In the Thrift Financial Report, gains 

and losses recognized upon sale of AFS debt securities are grouped with gains and losses 

recognized upon sale of loans HFS, while impairment losses for AFS securities are grouped with 

provisions for credit losses. With the exception of one bank in each group, the banks included in 

the aggregate information for failed banks with assets less than $1 billion and assets between $1 

billion and $10 billion each filed Call Reports, and therefore the Call Report format is used in the 

 

166 In the December 12, 2008 issue of American Banker, James Lockhart, the Director of the Federal Housing 

Finance Agency, stated “[m]y view on fair value is I think it provides useful information and is important to have. If 

an asset is impaired, it should be written down.” Steven Sloan, FHFA Director Talks Rate Plan, GSE Debt, FHLBs, 

American Banker, December 12, 2008. 

167 According to its website, the Basel Committee on Banking Supervision’s objective is to enhance understanding 

of key supervisory issues and improve the quality of banking supervision worldwide. It is best known for its 

international standards on capital adequacy, the Core Principles for Effective Banking Supervision, and the 

Concordat on cross-border banking supervision. The Committee's members come from Belgium, Canada, France, 

Germany, Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, Switzerland, the United Kingdom and the 

United States. Countries are represented by their central bank and also by the authority with formal responsibility for 

the prudential supervision of banking business where this is not the central bank. See www.bis.org/bcbs. The 

comment letter is available at: http://www.iasb.org/NR/rdonlyres/DE4ACB8D-1750-4288-BA8FD39F731B3326/0/CL94.pdf. 

168 Because goodwill reported under U.S. GAAP is currently excluded from Tier 1 capital, goodwill impairment 

charges recognized in income under U.S. GAAP do not currently impact Tier 1 capital, and are therefore not 

included as a fair value measurement that impacts Tier 1 capital. 
118

related exhibits. Each of the failed banks with assets greater than $10 billion filed Thrift 

Financial Reports, and therefore the Thrift Financial Report format is used in the related exhibits 

for these banks. 

1. Aggregate Failed Banks < $1 Billion of Total Assets 

As illustrated in Exhibit III.23 and Exhibit III.24, for failed banks with less than $1 billion of 

assets, the reduction in their capital was driven by increases in provisions for credit losses, which 

appear to have been caused by rising levels of non-performing loans. The level of nonperforming loans at the failed banks with less than $1 billion of assets far exceeded the levels of 

non-performing loans experienced by the non-failed banks of similar size. 

Exhibit III.23: Income Categories as a Percent of Net Interest Income 

-400%

-350%

-300%

-250%

-200%

-150%

-100%

-50%

0%

50%

100%

150%

Net Interest

Income (a)

Credit

Losses (b)

Real Estate

(c)

Loans HFS

(d)

AFS & HTM

(e)

Recurring

FV (f)

Net Pretax

(g)

12/31/2006 12/31/2007 3/31/2008 6/30/2008

(a) For all tables of this type: (1) for banks filing Call Reports, net interest income as reported in Schedule RI and (2) for banks filing TFRs, net interest 

income as reported in Schedule SO. 

(b) For all tables of this type: (1) for banks filing Call Reports, credit losses are based on provisions for loan and lease losses as reported in Schedule RI 

and (2) for banks filing TFRs, credit losses are based on provisions for losses on interest bearing assets as reported in Schedule SO, which includes 

fair value losses recognized on foreclosed property and impairment losses recognized on debt and equity securities. 

(c) For all tables of this type: (1) for banks filing Call Reports, the impact on income of other real estate owned is based on net gains (losses) on sales of 

other real estate owned as reported in Schedule RI, which includes gains and losses recognized upon sale of foreclosed property and fair value losses 

recognized prior to sale and (2) for banks filing TFRs, the impact on income of other real estate owned is based on operations and sale of repossessed 

assets as reported in Schedule SO, which includes costs of maintenance of foreclosed property and gains and losses upon sale. 

(d) For all tables of this type: (1) for banks filing Call Reports, the impact on income of loans HFS is based on net gains (losses) on sales of loans and 

leases as reported in Schedule RI, which includes gains and losses recognized upon sale and fair value losses recognized prior to sale and (2) for 

banks filing TFRs, the impact on income of loans HFS is based on the lower-of-cost-or-fair-value adjustments made to HFS assets as reported in 

Schedule So of the TFR, which does not include gains or losses recognized upon sale. 

(e) For all tables of this type: (1) for banks filing Call Reports, the impact on income of AFS and HTM securities is based on realized gains (losses) on 

AFS and HTM securities as reported in Schedule RI, which includes impairment losses recognized and (2) for banks filing TFRs, the impact on 

income of AFS and HTM securities is based on operations and sale of HFS assets and AFS securities and sales of securities HTM as reported in 

Schedule SO, which does not include impairment losses. 

(f) For all tables of this type: (1) for banks filing Call Reports, the impact on income of recurring fair value measurements is based on trading revenues 

and net gains (losses) on assets and liabilities accounted for under FVO as reported in Schedule RI and (2) for banks filing TFRs, the impact on 

income of recurring fair value measurements is based on gains and losses on financial assets and liabilities carried at fair value as reported in 

Schedule SO. 

(g) For all tables of this type: (1) for banks filing Call Reports, income (loss) before taxes and extraordinary items and other adjustments as reported in 

Schedule RI and (2) for banks filing TFRs, income before taxes as reported in Schedule SO. 
119

Exhibit III.24: Percent of Loans Non-Performing 

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

Columbian

First Priority

Main Street

Ameribank

First Integrity

Douglass

Meridan

Hume Bank

Alpha Bank

Freedom Bank

Community

Security Pac

All < $1 Billion*

12/31/2006 12/31/2007 3/31/2008 6/30/2008

*The percent of loans that are non-performing for all banks with less than $1 billion of assets is based on the information provided in “Quarterly 

Banking Profile” issued by the FDIC, which covers all FDIC-Insured Institutions for banks with asset size between $100 million and $1billion.

2. Aggregate Failed Banks > $1 Billion, but < $10 Billion of Total Assets

As illustrated in Exhibit III.25, increases in provisions for credit losses were also the most 

significant reason for the decrease in capital for the failed banks with assets between $1 billion 

and $10 billion. Exhibit III.26 shows that for these banks, the increase in credit losses appears to 

have been caused by rising levels of non-performing loans, which again far outpace the levels for 

all non-failed banks of similar size. 

Exhibit III.25: Income Categories as a Percent of Net Interest Income 

-350%

-300%

-250%

-200%

-150%

-100%

-50%

0%

50%

100%

150%

Net Interest

Income (a)

Credit

Losses (b)

Real Estate

(c)

Loans HFS

(d)

AFS & HTM

(e)

Recurring

FV (f)

Net Pretax

(g)

12/31/2006 12/31/07 3/31/08 6/30/08
120

Exhibit III.26: Percent of Loans Non-Performing 

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

First NB

Nevada

Silver State

Bank

ANB FNA Integrity

Bank

Franklin

Bank

PFF B & T All >$1

Billion and

<$10

Billion*

12/31/2006 12/31/2007 3/31/2008 6/30/2008

*The percent of loans that are non-performing for all banks with less than $1 billion of assets is based on the information provided in “Quarterly 

Banking Profile” issued by the FDIC, which covers all FDIC-Insured Institutions for banks with asset size between $1 billion and $10 billion. 

3. Failed Banks > $10 Billion of Total Assets 

As was found at the smaller banks, Exhibit III.27 shows that non-performing loans for the failed 

banks with assets greater than $10 billion also greatly exceeded the levels experienced generally 

for non-failed banks of similar size. 
121

Exhibit III.27: Percent of Loans Non-Performing 

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

Washington

Mutual

IndyMac Bank Downey S&L All >$10 Billion*

12/31/2006 12/31/2007 3/31/2008 6/30/2008

*The percent of loans that are non-performing for all banks with more than $10 billion of assets is based on the information provided in 

“Quarterly Banking Profile” issued by the FDIC, which covers all FDIC-Insured Institutions with assets greater than $10 billion. 

a. Washington Mutual 

Exhibit III.28 shows that credit losses were the most significant cause of declines in income at 

WaMu. During the periods analyzed, WaMu recognized fair value losses, but these losses were 

significantly less than the credit losses recognized during the same periods. As discussed more 

fully below, the fair value gains and losses WaMu recognized for financial instruments used to 

hedge its MSRs were partially offset by gains and losses recognized in income for changes in the 

fair value of its MSRs. 
122

Exhibit III.28: Income Categories as a Percent of Net Interest Income 

-250%

-200%

-150%

-100%

-50%

0%

50%

100%

150%

Net Interest

Income (a)

Credit

Losses (b)

HFS Losses

(c)

Gain/Loss

Sale (d)

Servicing

Income -

MSR FV (e)

Recurring

FV -

Financial (f)

Net Pretax

(g)

12/31/06 12/31/07 3/31/08 6/30/08

(a) For all tables of this type: Net interest income as reported in Schedule SO of the TFR. 

(b) For all tables of this type: Credit losses as reported in provisions for losses on interest bearing assets in Schedule SO of the TFR, which includes fair 

value losses recognized on foreclosed property and impairment losses recognized on debt and equity securities. 

(c) For all tables of this type: HFS losses is based on lower-of-cost-or-fair-value adjustments made to HFS assets as reported in Schedule SO of the TFR. 

(d) For all tables of this type: Gains / Losses on sales is based on sale of HFS assets and AFS securities as reported in Schedule SO of the TFR. 

(e) For all tables of this type: Servicing income is based on mortgage loan servicing fees and servicing amortization and valuation adjustments as 

reported in Schedule SO of the TFR. 

(f) For all tables of this type: Recurring fair value is based on gains and losses on financial assets and liabilities carried at fair value as reported in 

Schedule SO of the TFR. 

(g) For all tables of this type: Income before taxes as reported in Schedule SO of the TFR. 

In its 2007 Form 10-K, WaMu disclosed the following: 

The Company recorded a net loss for 2007 of $67 million, or $0.12 per diluted share, 

compared with net income of $3.56 billion, or $3.64 per diluted share, in 2006. The 

decline was primarily the result of significant credit deterioration in the Company’s 

single-family residential mortgage loan portfolio and significant disruptions in the capital 

markets, including a sudden and severe contraction in secondary mortgage market 

liquidity for nonconforming residential loan products. 

Based on disclosures made in its 2007 Form 10-K, during 2007 WaMu recognized 

approximately $500 million of fair value losses for trading securities, which primarily consisted 

of below investment grade retained interests in credit card securitizations, and $200 million of 

losses for fair value write-downs of non-conforming residential mortgage loans HFS, compared 

to $3.1 billion of credit losses recognized. 

Based on disclosures made in its first and second quarter 2008 Forms 10-Q, during the first 

quarter of 2008, WaMu recognized approximately $600 million of fair value gains due to 
123

derivatives that economically hedged the fair value of MSRs, which were partially offset by fair 

value declines in the related MSRs. During the second quarter of 2008, WaMu recognized losses 

on the derivatives it used to economically hedge the fair value of MSRs, which again were 

partially offset by gains in the fair value of its MSRs. In addition to the fair value effects of 

hedging activities, based on disclosures made in its second quarter 2008 Form 10-Q, it appears 

that WaMu recognized during the six months ended June 30, 2008 approximately $500 million 

of fair value losses for credit card retained interests and securities backed by Alt-A loans that 

were accounted for as trading securities, which was significantly less than the $9.4 billion of 

credit losses recognized during the same period. 

b. IndyMac 

As illustrated in Exhibit III.29, for IndyMac, the reduction of its capital was driven equally by 

the recognition of incurred credit losses and losses recognized for the decrease in fair value of its 

portfolio of HFS loans, investment securities, and derivatives. As discussed below, fair value 

gains and losses recognized for financial instruments used to hedge MSRs were partially offset 

by changes in the fair value of MSRs. Also, as discussed more fully below, a portion of the fair 

value losses IndyMac recognized related to incurred credit losses embedded in IndyMac’s 

trading securities portfolio. While IndyMac stated that it believed that a portion of the fair value 

losses it recognized during 2008 would recover over time, IndyMac also stated that it used its 

judgment to arrive at a fair value estimate for these securities that it believed did not represent a 

fire-sale valuation. 

Exhibit III.29: Income Categories as a Percent of Net Interest Income 

-500%

-400%

-300%

-200%

-100%

0%

100%

200%

Net Interest

Income (a)

Credit

Losses (b)

HFS Losses

(c)

Gain/Loss

Sale (d)

Servicing

Income -

MSR FV (e)

Recurring

FV -

Financial (f)

Net Pretax

(g)

12/31/06 12/31/07 3/31/08 6/30/08
124

In its 2007 Form 10-K, IndyMac disclosed the following: 

2007 was also severely impacted by worsening credit conditions as home prices and 

home sales declined. This has led to a significant increase in delinquencies in many 

products, particularly in higher loan-to-value (“LTV”) first and second lien loans and 

builder construction loans. As a result of the significantly worsening trends in home 

prices and loan delinquencies, we recorded significant charges, principally related to 

credit risk in our HFI (held-for-investment) portfolio, builder construction portfolio, and 

consumer construction portfolio. In addition, we recorded significant valuation 

adjustments in our loans held for sale, investment and non-investment grade securities 

and in residual securities. 

Based on disclosures made in its 2007 Form 10-K, IndyMac recognized its largest write-downs 

(valuation adjustments) for its non-investment grade securities and attributed a significant 

portion of these write-downs to incurred credit losses embedded in these securities. During 

2008, IndyMac recognized additional charges for credit losses and valuation adjustments. In its 

Form 10-Q for the quarter ended March 31, 2008, IndyMac stated that the declines in the fair 

value of its trading portfolio were primarily due to widening credit spreads on non-agency 

mortgage-backed securities, but that “[t]hese losses are unrealized and we believe are a result of 

reduced liquidity in the currently disrupted market for these bonds and that actual realized losses 

will be much lower. As a result, we expect to substantially recover these losses over time as we 

have the ability and intent to hold the securities to recovery or maturity.” IndyMac also disclosed 

that it used its judgment to arrive at what it believed was a reasonable fair value measurement, 

instead of basing the values solely based on broker quotes, as follows: 

Our determination of the fair values of our Level 3 assets, as described herein, involves 

significant judgment and, in our view, results in a reasonable measurement of fair value 

in accordance with the requirements of generally accepted accounting principles. These 

recorded fair values could be significantly in excess of the actual proceeds that would be 

received if we were forced to sell these assets in a short period of time into the current 

market which is characterized by illiquidity and opportunistic pricing by a limited 

number of buyers. In addition, given the current market illiquidity characterized by a 

lack of relevant and reliable market inputs for the private-label mortgage-related 

securities, had we relied solely on broker market indications the fair values of the trading 

securities would have declined by $120 million. 

Offsetting these decreases in fair value was an increase in fair value of the bank’s MSRs which 

resulted from slower loan prepayments given the changes in available refinancing opportunities. 

These increases in fair value did not affect regulatory capital, because the amount of MSRs 

included in capital is limited by the regulatory capital instructions. IndyMac disclosed in its 

Form 10-Q for the quarter ended March 31, 2008, “we are currently required to hold capital on a 

dollar-for-dollar basis against the portion of our MSRs that exceed our Tier 1 core capital, even 

though we have a long track record of successfully hedging this asset, and it is our highest 

earning asset in this environment.” IndyMac did not file a second quarter 2008 Form 10-Q, so it 

is not possible to determine the extent to which fair value losses recognized for the six month 
125

period ended June 30, 2008 related to instruments that were hedging MSRs, which were offset 

by fair value gains recognized for MSRs. 

c. Downey Savings and Loan 

Exhibit III.30 shows that, similar to banks with assets less than $10 billion, credit losses were the 

most significant cause of declines in income at Downey, and there were no losses recognized for 

recurring fair value measurements. Since Downey did not recognize any significant fair value 

losses during the periods reviewed, no analysis was needed to understand the source of fair value 

losses recognized. 

Exhibit III.30: Income Categories as a Percent of Net Interest Income

-350%

-300%

-250%

-200%

-150%

-100%

-50%

0%

50%

100%

150%

Net Interest

Income (a)

Credit

Losses (b)

HFS

Losses (c)

Gain/Loss

Sale (d)

Servicing

Income -

MSR FV

(e)

Recurring

FV -

Financial

(f)

Net Pretax

(g)

12/31/06 12/31/07 3/31/08 6/30/08

F. Evaluation of the Circumstances Surrounding Each Bank Failure 

In this subsection, the Staff provides publicly-obtainable descriptive information regarding the 

circumstances surrounding each of the 22 bank failures as of December 1, 2008. Based on 

review of this information, it does not appear that fair value reporting was the primary cause of 

any of these bank failures. While currently available analysis is, in some cases, limited due to 

the recent nature of many of these failures, the information analyzed by the Staff appears to 

indicate that the most significant factor in these bank failures was the underlying lending 

activities of the banks. For most of these banks, fair value accounting was applied in only 

limited circumstances. The decreasing levels of regulatory capital for these banks, which, for 

most, led to their failure, was caused primarily by recognized credit losses as opposed to the 

recognition of general fair value declines. One question that cannot be analyzed from the 

available filings is whether fair value accounting, if more extensively applied, could have 

prevented such failures by adding transparency to the lending and risk management practices of 

these banks. 
126

For the three banks with assets greater than $10 billion (WaMu, IndyMac and Downey), the Staff 

compared changes in the holding company’s stock price to changes in the U.S. GAAP-based 

book value per share. Based on this analysis, it appears that market concerns regarding these 

companies pre-dated any significant fair value losses that these companies recognized. 

Beginning in the third quarter of 2007, the stock price for each of these companies fell below the 

U.S. GAAP-based book value per share. 

Unless otherwise noted, the source of the financial information included in this section, such as 

capital levels, income statement, and balance sheet descriptions, is quarterly Call Reports or 

Thrift Financial Reports and, as applicable, public reports filed with the SEC. 

1. Failed Banks < $1 Billion of Total Assets 

As illustrated in Exhibit III.31, all of the failed banks with assets less than $1 billion experienced 

a significant decrease in their Tier 1 capital during 2007, causing their leverage ratio to fall 

below the average for that relative size bank. 

Exhibit III.31: Leverage Ratio for Banks with Less than $1 Billion of Assets 

-5%

0%

5%

10%

15%

20%

25%

30%

Columbian

Community

Security Pacific

First Priority

Main Street

Ameribank

First Integrity

Douglass

Meridan

Hume Bank

Alpha Bank

Freedom Bank

All < $1 Billion*

December 31, 2006 December 31, 2007 March 31, 2008 June 30, 2008

*The leverage ratio is Tier 1 capital divided by Average Assets. The source of the failed bank leverage ratios is the Call Report or TFR. The 

source of leverage ratios for all banks with assets under $1 billion is based on the information provided in “Quarterly Banking Profile” issued by 

the FDIC, which covers all FDIC-Insured Institutions for banks with asset size between $100 million and $1 billion. 

More detailed information about the circumstances leading up to these bank failures (in order of 

the size of the failed banks with assets less than $1 billion) is as follows: 

• The Columbian Bank and Trust – According to a statement made by the Kansas State Bank 

Commissioner Tom Thull, this bank was closed because the bank “would be unable to meet 

depositors’ demands in the normal course of business.”169 Columbian reported a sizable loss 

for the second quarter in 2008 due to a very large increase in loan loss provisions caused by 

 

169 Mark Davis, Area Sees a Second Bank Fail This Year, The Kansas City Star, August 23, 2008. 
127

problem real-estate loans. In July 2008 (a month before the bank’s failure), the FDIC and the 

Kansas Office of the State Bank Commissioner entered into an order for Columbian to cease 

and desist because “they had reason to believe that the Bank had engaged in unsafe and 

unsound banking practices and violations of law and regulation.”170 

• The Community Bank – During the nine months ended September 30, 2008, this bank 

recognized net losses of $28 million that were largely driven by credit losses and reduced the 

bank’s Tier 1 capital by more than 50%. 

• Security Pacific Bank – In April 2008, this bank consented to an Order to Cease and Desist 

issued by the FDIC and California’s Department of Financial Institutions (“CDFI”). The 

order states that the FDIC and the CDFI “determined that they had reason to believe that the 

[b]ank had engaged in unsafe or unsound banking practices.”171 Upon closing this bank, 

CDFI released a statement that this bank was being closely monitored and was ordered to 

“increase its capital reserves to a safe and sound level. But efforts by the bank to do so were 

unsuccessful.”172 This bank had a high concentration in construction real estate loans of 

which a significant percentage was non-performing. 

• Alpha Bank & Trust – This bank was opened in May 2006 and was never profitable. The 

bank expanded quickly and had a significant concentration of construction and land 

development loans. 

• Freedom Bank – In September 2008, this bank consented to an Order to Cease and Desist 

issued by the FDIC and the Division of Financial Institutions of the Florida Office of 

Financial Regulation (“OFR”). The order states that the FDIC and the OFR “determined that 

there is reason to believe that the [b]ank has engaged in unsafe or unsound banking practices 

and has committed violations of law and / or regulations.”173 Freedom Bank had been 

unprofitable since its opening in 2005. 

• First Priority Bank – This bank had been undercapitalized since 2007. The bank had a 

significant concentration in construction and development loans and a large percentage of 

those loans were past due. 

• Main Street Bank – This bank recognized net losses for each quarter in 2007 and the first two 

quarters of 2008 that significantly depleted its capital. In July 2008, the FDIC and the State 

of Michigan Office of Financial and Insurance Regulation ordered the bank to cease and 

desist from following unsafe or unsound banking practices, including engaging in hazardous 

lending and lax collection practices.174 

 

170 In re The Columbian Bank and Trust Company Order to Cease and Desist, FDIC-9-95b, OSBC 08-1 (FDIC and 

Kansas Office of the State Bank Commissioner, July 15, 2008). 

171 In re Security Pacific Bank Order to Cease and Desist, FDIC-08-063b (FDIC and CDFI, April 14, 2008). 

172 “State Closes Security Pacific Bank,” Press Release 08-11, CDFI (November 7, 2008). 

173 In re Freedom Bank Bradenton, Florida Order to Cease and Desist, FDIC-08-173b (FDIC, September 5, 2008). 

174 See In re Main Street Bank Northville, Michigan Order to Cease and Desist, FDIC-08-166b (FDIC and State of 

Michigan Office of Financial and Insurance Regulation, July 22, 2008). 
128

• Ameribank – This bank’s primary federal regulator, the OTS, issued a press release upon 

closure stating that the bank’s troubles “stemmed from excessive growth in construction 

rehabilitation loans, which provided financing for the rehabilitation of distressed properties, 

predominantly in low- to moderate-income housing markets. The quarter ending June 30, 

2008 marked the fourth consecutive quarter of net losses and capital erosion for 

Ameribank.”175 

• Douglass National Bank – This bank’s primary federal regulator, the OCC, issued a press 

release upon closure stating “the bank had experienced substantial dissipation of assets and 

earnings due to unsafe and unsound practices.”176 

• First Integrity Bank – As was done for Douglass National Bank, the primary federal regulator 

of First Integrity Bank, the OCC, issued a press release upon closure stating “the bank had 

experienced substantial dissipation of assets and earnings due to unsafe and unsound 

practices.”177 

• Meridian Bank – In July 2008, the FDIC and the Illinois Department of Financial and 

Professional Regulation Division of Banking entered into an order for Meridian Bank to 

cease and desist because they had reason to believe that the bank had engaged in unsafe and 

unsound banking practices. The order required the bank to cease and desist engaging in 

hazardous lending and lax collection practices.178 

• Hume Bank – According to a press release issued by Missouri Commissioner of Finance D. 

Eric McClure, the bank’s failure was “a direct result of alleged improprieties by former bank 

management, which resulted in past due loans not being reported and the true condition of 

the bank being misrepresented. Most of these loans were poorly conceived and inadequately 

serviced; resulting in losses which exhausted the bank’s capital and ultimately resulted in its 

failure.”179 

2. Failed Banks > $1 Billion, but < $10 Billion of Total Assets

As illustrated in Exhibit III.32, all of the failed banks with assets between $1 and $10 billion also 

experienced decreases in their Tier 1 capital that caused their leverage ratio to fall in most cases 

significantly below the average for that relative sized bank. 

 

175 “OTS Closes Ameribank and Appoints FDIC Receiver,” OTS 08-045, OTS (September 19, 2008). 

176 “OCC Closes Douglass National Bank and Appoints FDIC Receiver,” NR 2008-7, OCC (January 25, 2008). 

177 “OCC Closes First Integrity Bank, N.A. and Appoints FDIC Receiver,” NR 2008-62, OCC (May 30, 2008). 

178 See In re Meridian Bank Eldred, Illinois Order to Cease and Desist, FDIC-08-121b, 2008-DB-29 (FDIC and State 

of Illinois Department of Financial and Professional Regulation Division of Banking, July 15, 2008). 

179 “Commissioner of Finance Closed Hume Bank,” Release, Missouri Department of Insurance Financial 

Institutions & Professional Registration (March 7, 2008). 
129

Exhibit III.32: Leverage Ratio for Banks with Assets Greater than $1 Billion, but Less than $10 

Billion 

0%

2%

4%

6%

8%

10%

12%

Franklin

Bank

PFF B & T First NB

Nevada

Silver State

Bank

ANB FNA Integrity

Bank

All >$1

Billion and

<$10

Billion* December 31, 2006 December 31, 2007 March 31, 2008 June 30, 2008

*The leverage ratio is Tier 1 capital divided by Average Assets. The source of the failed bank leverage ratios is the Call Report or TFR. The 

source of leverage ratios for all banks with assets between $1 and $10 billion is based on the information provided in “Quarterly Banking Profile” 

issued by the FDIC, which covers all FDIC-Insured Institutions for banks with asset size between $1 billion and $10 billion. 

More detailed information about the circumstances leading up to these bank failures (in order of 

size of failed banks with assets between $1 and $10 billion) is as follows: 

• Franklin Bank – This bank is a subsidiary of a public company that became delinquent in its 

SEC filings during 2008 because of an internal investigation that uncovered accounting 

errors related to delinquent loans, foreclosed property, and loan modifications, as well as in 

other areas. In November 2008, this bank consented to an Order to Cease and Desist issued 

by the FDIC and the Texas Department of Savings and Mortgage Lending (“Texas 

Department”). The order states that the FDIC and the Texas Department “determined that 

they had reason to believe that the [b]ank had engaged in unsafe or unsound banking 

practices and had violated laws and regulations.”180 The underlying cause of this bank’s 

failure appears to be credit losses on real estate and construction loans. During the quarter 

ended September 30, 2008, the bank recognized credit losses of $147 million, which reduced 

Tier 1 capital to $113 million or to 2% of average assets. 

• PFF Bank and Trust – This bank’s primary federal regulator, the OTS, issued a fact sheet 

describing the circumstances that led to the bank’s closure. The fact sheet stated, “[t]he 

[b]ank’s asset quality rapidly declined beginning in late 2007. The [b]ank had a large 

concentration of tract construction and land loans. The steadily declining home values in the 

areas where the underlying properties are located have contributed to this deterioration. 

...Because of the [b]ank’s rapidly deteriorating asset quality and continuing negative affect 

 

180 In re Franklin Bank, S.S.B. Houston, Texas Order to Cease and Desist, FDIC-08-297b (FDIC and Texas 

Department of Savings and Mortgage Lending, November 4, 2008). 
130

on earnings and capital, the [b]ank was in an unsafe and unsound condition to transact 

business.”181

• First National Bank of Nevada and First Heritage Bank – The failures of these two banks are 

grouped together because they are subsidiaries of the same holding company, First National 

Bank Holding Company. First Heritage Bank became critically undercapitalized as result of 

the failure of First National Bank of Nevada. The underlying cause of these bank failures 

appears to be credit losses on Alt-A residential mortgage loans purchased from 

correspondents and a concentration in problem construction and development loans.182 The 

primary federal regulator of these banks, the OCC, reported that there was no reasonable 

prospect of these banks becoming adequately capitalized without federal assistance.183

• Silver State Bank – The closure of this bank appears to have resulted from the inability of the 

bank to meet depositor needs.184 The bank specialized in construction and land development 

loans. As of June 2008, approximately a quarter of its construction and land development 

loans were classified as either 90 days or more past due or non-accrual. 

• ANB Financial – This bank operated under a formal agreement entered into in June 2007 

with its primary federal regulator, the OCC. In the enforcement action, the OCC said it 

found “unsafe and unsound banking practices relating to the supervision of the affairs of the 

[b]ank.”185 

• Integrity Bank – A spokesman for the FDIC, the primary federal regulator for Integrity Bank, 

was quoted as saying that the bank failed due to its aggressive pursuit of construction loans, 

coupled with falling real estate values and inadequate risk management.186 

3. Failed Banks > $10 Billion of Total Assets 

As illustrated in Exhibit III.33, unlike the leverage ratios of the smaller banks, the largest and 

third-largest banks to fail (WaMu and Downey) did not experience a dramatic decrease in their 

Tier 1 capital. On the other hand, the second largest bank to fail (IndyMac) did experience 

during 2008 a decline in its leverage ratio that far exceeded the experience of the average bank of 

that relative size. As illustrated in Exhibit III.34, the market share price for all three companies 

began to decline significantly starting in July 2007 and fell below U.S. GAAP-based book value 

 

181 “OTS Closes Two California Thrifts and Appoints FDIC Receiver,” OTS 08-057, OTS (November 21, 2008). 

182 See Joe Adler, Declaring A Failure: When Should It Happen? Some See a Need for Quicker Action on 

Reserving, Disclosure, American Banker, August 7, 2008. 

183 See “OCC Closes First National Bank of Nevada and Appoints FDIC Receiver,” NR 2008-87, OCC (July 25, 

2008) and “OCC Closes First Heritage Bank, N.A., Newport Beach, CA and Appoints FDIC Receiver,” NR 2008-

87, OCC (July 25, 2008). 

184 See Nicole Lucht, FDIC Takes Over Silver State Bank of Henderson, Las Vagas Sun, September 5, 2008. 

185 In re Agreement By and Between ANB Financial National Association Rogers, Arkansas and The Comptroller of 

the Currency, #2007-081 (OCC, January 29, 2008). 

186 See Madlen Read, Georgia Bank Closes in 10th Failure This Year, Associated Press, August 30, 2008. 
131

per share. A chronology of certain significant market events is included in this exhibit to provide 

background on events which may have affected share price. 

Exhibit III.33: Leverage Ratio for Banks with Assets Greater than $10 Billion 

0%

2%

4%

6%

8%

10%

12%

Washington

Mutual

IndyMac Bank Downey S&L > $10 Billion*

December 31, 2006 December 31, 2007 March 31, 2008 June 30, 2008

The leverage ratio is Tier 1 capital divided by Average Assets. The source of the failed bank leverage ratios is the TFR. The source of leverage 

ratios for all banks with assets greater than $10 billion is based on the information provided in the “Quarterly Banking Profile” issued by the 

FDIC, which covers all FDIC-Insured Institutions for banks with asset size greater than $10 billion. 
132

Exhibit III.34: Weekly Common Stock Price and Quarterly Book Values for Failed Banks with 

Assets Greater than $10 Billion

Market Price vs. Book Value

0

10

20

30

40

50

60

70

80

12/29/2006 3/29/2007 6/29/2007 9/29/2007 12/29/2007 3/29/2008 6/29/2008 9/29/2008

Per Share Dollar Value

@WAMUQ(P) @WAMUQ(BV) @IDMCQ(P) @IDMCQ(BV) @DWNFQ(P) @DWNFQ(BV)

(B) (C) (D) (E) (F) (H) (K) (I) (J) (A) (G)

Weekly common stock prices are the closing price for the last trading day for a week provided by Datastream. Book values are calculated from 

Forms 10-K and 10-Q, based on period end total equity excluding preferred stock divided by common stock outstanding as of period end. 

(A) February 2007: HSBC Financial announces increase in loan impairment provision estimates for the period 

ended December 31, 2006 because of accelerated delinquency trends across the US sub-prime mortgage 

market.187

(B) April 2007: New Century, a major sub-prime lender, files for bankruptcy protection.188

(C) June 2007: Bear Stearns forced to support hedge funds invested in sub-prime mortgage securities.189

(D) July 2007: Credit rating agencies downgrade hundreds of classes of residential mortgage-backed securities. 

Countrywide Financial, largest US mortgage lender, announces softening of home prices has led to increased 

delinquencies for prime borrowers.190

(E) August 2007: American Home Mortgage, a prime and Alt-A lender, files for bankruptcy protection.191 

(F) September 2007: Foreclosure activity for the month of August 2007 is reported as increasing 37%.192

(G) November 2007: Hilltop Holdings indicates interest in acquiring Downey Financial.

(H) January 2008: Federal Reserve lowers federal funds rates by 75 basis points.

(I) April 2008: Washington Mutual announces that it is raising $7 billion of capital.193

(J) July 2008: IndyMac Bank is closed by federal regulators.

 

187 HSBC Holdings plc, Form 6-K, filed February 8, 2007. 

188 New Century Financial Corporation, Form 8-K, filed April 6, 2007. 

189 The Bear Stearns Companies, Inc., Form 8-K, filed June 26, 2007. 

190 Countrywide Financial Corporation, Form 8-K, filed July 24, 2007. 

191 American Home Mortgage Investment Corp., Form 8-K filed, August 9, 2007. 

192 “Foreclosure Activity Increase 37 Percent in August,” RealtyTrac Press Release (September 18, 2007. Revised 

October 25, 2007). 

193 Washington Mutual Inc., Form 8-K, filed April 9, 2008. 
133

(K) September 2008: Fannie Mae and Freddie Mac placed into conservatorship by federal regulators. Bank of 

America announces it will acquire Merrill Lynch. Lehman files for bankruptcy. Government pledges $85 

billion to AIG.

a. Washington Mutual

Instead of reduced capital, the proximate cause for the failure of WaMu appears to have been 

dramatic increase in deposit outflows sparked by concerns about the quality of the bank’s 

mortgage loan assets. WaMu’s primary federal regulator, the OTS, released a fact sheet on 

September 25, 2008, explaining WaMu’s failure. This fact sheet states the following: 

Beginning in late 2006 through today, WMB [WaMu] was proactively changing its 

business strategy to respond to declining housing and market conditions. Changes 

included tightening credit standards, eliminating purchasing and originating subprime 

mortgage loans, and discontinuing underwriting option ARM and stated income loans. 

Management reduced loans originated for sale and transferred held for sale loans to the 

held for investment portfolio. WMB was focusing on shrinking its balance sheet and 

developing a retail strategy through its branch operations. ...Since July 2008, the pressure 

on WMB increased as market conditions continued to worsen. Significant deposit 

outflows began on September 15, 2008. During the next eight business days, WMB 

deposit outflows totaled $16.7 billion, shortening the time available to augment capital, 

improve liquidity, or find an equity partner. Given the [b]ank’s limited sources of funds 

and significant deposit outflows, it was highly likely to be unable to pay its obligations 

and meet its operating liquidity needs.194

There are a number of factors that likely contributed to market concerns about the viability of 

WaMu. One factor is that during late 2007 and 2008, as demonstrated in its financial filings with 

the SEC, WaMu’s management was continuously updating its estimate of credit losses to show 

higher and higher losses. In its Form 10-Q for the quarter ended June 30, 2008, WaMu disclosed 

the following: 

 

The Company recorded a net loss in the second quarter of 2008 of $3.33 billion, 

compared with net income of $830 million in the second quarter of 2007, primarily due to 

the Company’s significant increase in loan reserves. ...Adverse trends in key credit risk 

indicators, including high inventory levels of unsold homes, rising foreclosure rates, the 

significant contraction in the availability of credit for nonconforming mortgage products 

and negative job growth trends exerted severe pressure on the performance of the singlefamily residential (“SFR”) loan portfolio, particularly loans in geographic areas in which 

the Company’s lending activities have been concentrated in recent years. 

General reports of fraudulent mortgage underwriting practices in the industry, as well as specific 

charges alleged against certain appraisal firms utilized by WaMu,195 only contributed to the 

 

194 “OTS Fact Sheet on Washington Mutual Bank,” OTS 08-046A, OTS (September 25, 2008). 

195 New York Attorney General Andrew Cuomo is quoted saying “By allowing Washington Mutual to hand-pick 

appraisers who inflated values, First American helped set the current mortgage crisis in motion.” Carl Gutierrez, 
134

uncertainty surrounding the quality of loans it held. For instance, news outlets reported that the 

stock price of WaMu fell as much as 14% after an analyst report released in June 2008 suggested 

WaMu was underestimating losses on home loans.196 The elevated concerns in the general 

financial environment caused by the failures of other institutions also likely contributed to 

concerns regarding WaMu. The failure of IndyMac in July 2008 suggested that banks and 

financial services firms with heavy exposure to real estate prices were vulnerable. As illustrated 

in Exhibit III.34, WaMu’s share price fell from $45 on January 1, 2007 to less than $5 on July 

11, 2008, the date of IndyMac’s failure. While WaMu reported in its second quarter Form 10-Q 

filed on August 11, 2008 a book value per common share of $13 as of June 30, 2008, WaMu’s 

stock price continued to decline below $5 a share (significantly less than U.S. GAAP reported 

equity) in August and September 2008. The problems at other large financial services firms in 

the weeks preceding deposit outflows at WaMu, including the conservatorship of Fannie Mae 

and Freddie Mac, Lehman filing for bankruptcy, the announced acquisition of Merrill Lynch by 

Bank of America, and the federal rescue of AIG, likely raised concerns that WaMu would not be 

able to raise capital should loan losses continue to rise. 

b. IndyMac 

As illustrated in Exhibit III.33, IndyMac experienced a significant decrease in capital levels 

during 2008. It appears that declining asset performance, past reliance on an originate-to-sell 

business model for higher risk loans, and highly mobile brokered deposits, along with the press 

highlighting IndyMac’s vulnerability, appear to have eroded the public’s confidence in the bank. 

As illustrated in Exhibit III.34, IndyMac’s common stock price per share fell from $45 on 

January 1, 2007 to $3 a share on May 12, 2008, the date on which IndyMac filed a Form 10-Q 

showing a book value per common share of $11. The decline in IndyMac’s share price 

(significantly below U.S. GAAP reported book value) may potentially suggest that investors 

factored in information not reflected in the bank’s reported balance sheet. IndyMac’s primary 

federal regulator, the OTS, released a fact sheet on July 11, 2008 explaining IndyMac’s failure. 

This fact sheet describes the failure as follows: 

 New York A.G. Cuomo Sues First American, Alleges Fraud, Forbes, November 11, 2007. In its Form 10-Q for the 

quarter ended June 30, 2008, WaMu describes the case as follows: 

On November 1, 2007, the Attorney General of the State of New York filed a lawsuit against First 

American Corporation and First American eAppraiseIT. The People of the State of New York by Andrew 

Cuomo v. First American Corporation and First American eAppraiseIT, No. 07-406796 (N.Y. Sup. Ct. 

Filed Nov. 1, 2007). According to the Attorney General's Complaint, eAppraiseIT is a First American 

subsidiary that provides residential real estate appraisal services to various lenders, including the Bank. The 

Attorney General asserts that, contrary to various state and federal requirements and the Uniform Standards 

of Professional Appraisal Practice, the Bank conspired with eAppraiseIT in various ways to falsely increase 

the valuations done by appraisers eAppraiseIT retained to perform appraisals on Bank loans. First 

American Corporation and First American eAppraiseIT are not affiliates of the Company, and neither the 

Company nor the Bank is a defendant in the case. 

196 See, e.g., a Bloomberg article citing a statement made by UBS AG analyst Eric Wasserstrom regarding his belief 

that WaMu was underestimating losses on home loans as a cause for the drop in WaMu’s stock price. Ari Levy & 

Linda Shen, Washington Mutual Falls to Lowest in 16 Years on Loss Estimate, Bloomberg.com, June 9, 2008. 

(available at http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aPtqGUO0S7G0) 
135

From June 2005 to March 2008, IndyMac grew from $18 billion to $32 billion. The 

growth was mainly due to the Alt-A mortgage loan production pipeline, private label 

mortgage-backed securities and MSRs. IndyMac Alt-A loans were generally jumbo 

loans that were underwritten largely based on the borrower’s credit score and the loan-tovalue ratio, and many did not have full verification of income or assets (less than full 

documentation loans). Over the past nine months, IndyMac incurred significant losses, 

severely depleting capital and jeopardizing the institution’s continued viability. 

IndyMac’s mortgage banking operations focused on Alt-A single family mortgages, 

which the bank could not securitize and sell in late 2007 due to the decline in the 

secondary market for non-agency mortgage loans. IndyMac moved $10.7 billion of loans 

intended for sale to the category of “held for investment” in the fourth quarter of 2007. 

In response to market conditions and OTS concerns, IndyMac changed its business plan 

in November 2007 to focus on originating mortgage loans qualifying for purchase by the 

government sponsored enterprises (agency-eligible loans). With limited prospects of 

maintaining adequate capitalization, IndyMac sought to obtain a significant capital 

infusion or to find a buyer. The pressure on IndyMac required time to be relieved. 

Negative news coverage and a subsequent deposit run beginning on June 27, 2008 took 

that time away. The deposit run followed the release of a letter from Senator Charles 

Schumer to the FDIC and OTS on June 26, 2008. The letter outlined the Senator’s 

concerns with IndyMac. The institution did not have sufficient access to liquidity to 

withstand the deposit run. With insufficient liquidity to meet its obligations, and no 

viable alternatives to return to profitability and restore capital adequacy, IndyMac was in 

an unsafe and unsound condition to transact business.197

c. Downey Savings and Loan 

Although Downey, at the time of its closure, had not experienced as significant a decline in its 

capital levels as those experienced by IndyMac, the closure of this bank was based on the 

expectation that such significant additional losses existed in the bank’s portfolio and that it 

would not be possible for the bank to remain adequately capitalized. Downey’s primary federal 

regulator, the OTS, released a fact sheet on November 21, 2008 explaining the failure. This fact 

sheet describes the failure as follows: 

Downey had a concentration of nontraditional mortgages, including payment option 

adjustable rate mortgages (ARMS) and hybrids. The majority of the loans in this 

portfolio were originated by mortgage brokers and were based on the borrowers’ stated 

incomes. Many of the borrowers utilized the negative amortization features of the option 

ARM loans and borrowers were exposed to significant payment adjustments when the 

initial adjustable loan rate reset. The [B]ank discontinued option ARM and stated income 

lending, but the loans already in the portfolio are experiencing high delinquency levels 

and causing material negative earnings. The Bank posted a net loss of $50.9 million for 

2007 because of necessary provisioning for losses on loans. In 2008, the Bank posted net 

losses of $246 million in the first quarter, $217 million for the second quarter, and $74 

million in the third quarter. The projected cumulative losses for the loan portfolio were 

 

197 “OTS Fact Sheet on IndyMac Bank,” OTS 08-029A, OTS (July 11, 2008). 
136

substantial ...Downey was likely to incur additional losses that would deplete all or 

substantially all of capital.198

As illustrated in Exhibit III.34, in 2008, the market price of Downey’s shares fell significantly 

below Downey’s reported book value, potentially suggesting that market participants may have 

factored in information not reflected in Downey’s balance sheet. Downey reported in its Form 

10-Q for the quarter ended September 30, 2008 that two purported shareholder class actions had 

been brought against it. As described in its Form 10-Q, in these cases, the 

plaintiffs contend that the defendants concealed that (a) the Bank’s portfolio of option 

ARMs contained millions of dollars worth of impaired and risky securities; (b) the Bank 

had been aggressive in acquiring loans from mortgage brokers that were highly risky; (c) 

the Bank had failed to properly account for highly leveraged loans; (d) the Bank had 

inadequate underwriting practices, which led to large numbers of loan defaults; and (e) 

the Bank had not adequately reserved for option ARM loans. 

 G. Impact of Fair Value Accounting on Other Distressed Financial Institutions 

As mandated by the Act, this section of the study examines the impact of fair value accounting 

on bank failures in 2008. Although not mandated for study by the Act, an overview of the 

circumstances leading to the financial distress of other financial institutions based upon Staff 

observation through its prudential oversight function is provided in order to consider whether 

any additional insight could be gained between fair value accounting and financial institution 

failures in general. 

Despite unprecedented efforts to stabilize the financial markets, a number of long-standing 

financial institutions faced such dire liquidity positions that they decided bankruptcy or 

acquisition was inevitable in 2008. As noted previously, some have asserted that these 

circumstances were the result of fair value accounting along with the accompanying guidance on 

measuring fair value under SFAS No. 157. Instead of accounting and reporting being the crisis’ 

primary driver, the observations indicate that the liquidity positions of some financial 

institutions, concerns about asset quality, lending practices, risk management practice, and a 

failure of other financial institutions to extend credit appear to be the primary drivers. 

For instance, Bear Stearns experienced a rapid deterioration of liquidity during March of 2008 

akin to a “run on the bank” as seen in earlier financial crisis.199 However, the circumstances 

surrounding Bear Stearns were unique as it was the first time that a well-capitalized major 

investment bank experienced a crisis of confidence that resulted not only in a loss of unsecured 

financing, but also short-term secured financing. This occurred even though the collateral it was 

able to provide was high quality, such as agency securities, and had a market value that exceeded 

the amount to be borrowed. 

 

198 “OTS Fact Sheet on Downey Savings and Loan Association,” OTS 08-057A, OTC (November 21, 2008). 

199 See Testimony of Christopher Cox, Chairman, SEC, before the Committee on Banking, Housing and Urban 

Affairs of the United States Senate on Recent Events in the Credit Markets (April 3, 2008). 

 
137

Bear Stearns’ difficulties began when certain over-the-counter derivatives counterparties sought 

to novate contracts, or replace their trades with Bear Stearns by entering into new contracts with 

other dealers, while simultaneously some of Bear Stearns’ prime brokerage clients began moving 

their cash balances elsewhere. The Staff believes that these initial decisions to no longer transact 

with Bear Stearns influenced others, and quickly other counterparties, clients, and lenders 

reduced their exposure to Bear Stearns. Ultimately, counterparties simply would not engage in 

derivatives transactions with Bear Stearns and lenders would not engage in stock lending and triparty repurchase transactions with Bear Stearns. Bear Stearns’ hedge fund clients withdrew their 

funds and certain banks hesitated to clear for Bear Stearns. By March of 2008, Bear Stearns 

faced the prospect of either filing for bankruptcy or quickly concluding an acquisition agreement 

with a larger partner. The sequence of these events indicates that liquidity pressure, caused by a 

lack of market confidence in Bear Stearns, was the likely driver to the demise of Bear Stearns. 

These liquidity pressures and decline in market confidence were precipitated by concerns about 

the quality of assets held by Bear Stearns and the poor risk management decisions that permitted 

such holdings to be accumulated. 

After Bear Stearns’ bankruptcy, other investment banks, including Lehman, continued to have 

difficulty selling mortgage-related assets as the market for such assets continued to deteriorate 

over the summer of 2008. The financial distress of the GSEs, including Freddie Mac and Fannie 

Mae, increased in September 2008 due to worsening real estate values exacerbated by the 

illiquidity of mortgage-related assets and faltering market confidence in these financial 

institutions. 

These events led to Lehman’s bankruptcy filing, as well as the distress experienced by the GSEs 

and other financial institutions. The challenges facing Lehman became clear to the market with 

the reporting of results for the second quarter of 2008. At that time, Lehman disclosed a 

significant concentration of what have been termed “legacy” assets. These illiquid assets, which 

fell into three distinct categories (residential real estate, commercial real estate, and acquisition 

finance), were accumulated in anticipation of future securitization. However, when the 

securitization market ceased to function, these assets, which Lehman had expected to hold for 

only a short period, were required to be held on its balance sheet. 

In the days prior to Lehman’s filing for bankruptcy in September 2008, secured funding broadly 

remained in place. However, other critical business arrangements were bearing down on the firm 

and straining Lehman’s liquidity. Most critically, a number of banks that had clearing 

relationships with Lehman significantly increased their collateral or deposit requirements, 

particularly around those products that involve non-simultaneous settlement. Given the 

magnitude of these clearing firm issues, and the likelihood that the demands would continue to 

increase, Lehman’s management believed it would be difficult for the firm to operate normally 

and meet its obligations. 

The week following Lehman’s bankruptcy filing, the remaining stand-alone investment banks 

experienced severe downward pressure on their stock price. Bank of America Corporation’s 

acquisition of Merrill Lynch occurred nearly simultaneously with Lehman’s bankruptcy. The 

expedited application of The Goldman Sachs Group, Inc. and Morgan Stanley, two firms widely 
138

perceived to be the strongest, best-capitalized, and most resilient of the investment banks, to 

become bank holding companies indicated that the management of these firms determined that 

they could not continue without adopting the federally-subsidized funding model enjoyed by key 

competitors, which included federal government support through federally-insured deposits and 

broad access to a central bank as a liquidity backstop. 

Although not detailed in this study, the Staff also believes that the liquidity pressures faced by 

Bear Stearns, Lehman, and the other investment banks were also encountered by many other 

financial institutions, including AIG and other banks. Based on this analysis, and similar to the 

observations concerning 2008 bank failures in this study, liquidity pressures brought on by risk 

management practices, and concerns about asset quality precipitated by a rapid decline in 

confidence in these financial institutions, appears to be the primary cause of their financial 

distress and in some cases bankruptcy. 
139

IV. Impact of Fair Value Accounting on the Quality of Financial 

Information Available to Investors 

This section of the study discusses the views of investors and other financial statement users on 

the role of fair value accounting and whether it enhances or impairs their understanding of 

financial information. Specifically, this section explores the following areas: 

• Investor and user views about the use of fair value measurements, as expressed in comment 

letters in response to the SEC’s request for comment on fair value accounting standards200

and other public statements, as well as a review of a sample of analyst reports to determine 

whether user practice is consistent with these views; 

• A summary of investor and user views expressed at the Commission’s three public 

roundtables,201 presented in the context of debate with other constituents; 

• Recommendations related to fair value accounting measurements from two recent federal 

advisory committees; 

• Prior published Staff views on fair value accounting matters; and 

• A summary of available academic studies addressing the impact of fair value accounting on 

the quality of information available to investors. 

As described more fully below, the results of the Staff’s study indicate that there is broad support 

among investors for the view that fair value information is useful and increases the quality of 

financial information available to them. For example, investors indicated that fair value provides 

more reliable and comparable information than amounts determined using alternative methods. 

A. Investor and User Views About the Use of Fair Value Measurements 

As the debate around fair value accounting intensified during 2008, investors and other users 

have generally expressed support for current fair value reporting standards. Recurring themes 

are that it improves the transparency of a firm’s investments and improves comparability across 

firms. 

1. Comment Letters and Other Public Statements 

The Commission received 186 comment letters from a variety of constituents in response to its 

request for comment on fair value accounting.202 Consistent with the mandate of the Act, this 

section presents a representative survey of investor views in the form of quotations from relevant 

comment letters and other public statements to demonstrate perspectives held by institutional and 

 

200 See Appendix A for a summary of the comments received in response to the SEC’s request for public comment. 

201 See Appendix B for a list of roundtable participants. 

202 This number reflects comments received through December 15, 2008. 
140

retail investors, large equity research practices, credit rating agencies, and other users. However, 

other constituents may have expressed alternative views; accordingly, this survey should be read 

in conjunction with the more complete summary of the comment letters in Appendix A. 

 a. Representative Survey of Comment Letters 

Investors Technical Advisory Committee (“ITAC”) – 

We are especially concerned to witness in recent weeks calls by some politicians, 

banking and insurance industry lobbyists, and other parties for changes, suspensions, 

or overrides to fair value accounting. In our view, those activities erode the notion of 

independent private sector accounting standard setting supported by a thorough and 

public due process that gives pre-eminence to the views of investors. ... We 

encourage the Commission to closely examine the potential grave consequences to 

investors’ confidence in financial reporting if this important tenet is impaired. ... 

ITAC, consistent with the views of most U.S. investors and financial analysts, 

believes that financial reporting would be substantially improved if fair value was 

the required measurement approach for all financial instruments reported by 

financial institutions as well as non-financial services enterprises. ... Although ITAC 

recognizes that certain improvements to presentation and disclosures for fair value 

measurements may be warranted, we maintain our strong support of fair value 

accounting and our belief that it should serve as the principal measure for reporting 

financial instruments.203

 

Center for Audit Quality, CFA Institute, Consumer Federation of America, Council of 

Institutional Investors, and Investment Management Association – 

In the specific case of fair value reporting, investors require an accounting standard 

that reports a relevant and useful value of financial instruments regardless of the 

direction of markets. Fair value accounting with robust disclosures provides more 

reliable, timely, and comparable information than amounts that would be reported 

under other alternative accounting approaches.204

CFA Institute – 

CFA Institute’s support for fair value accounting is backed by a poll conducted of 

our 12,000 person EU membership, which shows that 79% were opposed to 

suspension of fair value and 85% believe that suspending fair value would 

decrease investor confidence in the banking system. We acknowledge that there are 

some limitations and implementation difficulties associated with the fair value 

 

203 Letter from ITAC (original footnotes omitted). 

204 Letter from Joint (November 14, 2008). See also letter from CII (“We believe that fair value accounting for 

financial instruments, complemented by robust disclosures, is superior to other accounting alternatives in: (1) 

providing investors clear and accurate information and (2) restoring the free flow of money and credit to the U.S. 

and global capital markets.”) 
141

measurement approach including measurement error. But these limitations are not 

unique to the fair value approach. In fact, fair value has a well established history of 

application under US Generally Accepted Accounting Principles (US GAAP) for 

financial assets for 15 years. Considering its overall benefits, fair value is the best 

available alternative of measuring financial instruments and on balance, it 

significantly contributes to the overall transparency of financial institutions.205 

Investment Company Institute – 

[W]e believe financial reporting that requires the use of mark-to-market or fair value 

accounting to measure financial instruments better serves the interests of investors 

and our capital markets than alternative cost-based measures.206

International Corporate Governance Network – 

The impact of SFAS 157 and other accounting standards promote improved 

transparency and disclosure of information to ensure present and potential investors, 

shareowners, creditors, management and other users have the most accurate 

information to make investment, credit and resource allocation decision. We support 

the transparency that has been given by fair value, but feel that fair value reporting is 

still an evolving target and much more work is required to find the most appropriate 

language to communicate information about financial position and performance. 

There may be serious questions with respect to the application of fair value when 

markets are not functioning properly. ... The role of the auditor in the process of 

reporting the quality of financial instruments should be addressed. Financial 

reporting must meet the needs of investors and other users of financial reporting.207

Jeffery B. Cross, retired securities analyst – 

As a retired securities analyst I have always had a low opinion of so called “fair 

value” accounting because it allows far too much leeway for interpretative judgment. 

...Any cogent investor would rather see things carried at amortized costs and make 

their own judgment as to the degree to which underlying long term value might be 

more or less than amortized cost (more detailed disclosures in quarterly reports 

would be a very important help in this and an excellent improvement in market 

efficiency long term). Mark to market, while conceived with the best intentions in 

mind, causes both too much noise in the system and produces a degree of balance 

sheet variation wholly inconsistent with orderly markets, as must now be all too 

obvious.208 

 

205 Letter from CFA (November 11, 2008) (emphasis in original). 

206 Letter from ICI. 

207 Letter from ICGN. 

208 Letter from Cross. 
142

David Hodge, Glimbal Capital Management – 

I believe that the Commission should immediately exercise the powers granted it 

under Section 132 of EESA and suspend SFAS 157 for not less than 12 months, 

retaining required disclosure in the Notes of financial statements but setting aside 

fair value recognition in the balance sheet for the immediate term, to effect a 

‘cooling off’ period. ... This said, SFAS 157 is an admirable goal, but the 

implementation has clearly been mishandled, and consequences have been far 

beyond what anybody anticipated at its inception. I applaud fair value disclosure, 

and I recognize great value in this. I would even go so far as to say that disclosure in 

the Notes alone would achieve the stated goal of transparency. No investor looking 

into investing in securities should be satisfied with mere financial statement analysis. 

As I know, because I am a security analyst, far deeper diligence is required, with the 

first reading after the financial statements being the Notes.209

Dan Nguyen, CFA, MBA – 

The goal of the FMV [fair market value] accounting is to provide transparency and 

useful information to investors. So far, the FMV accounting has provided no further 

transparency and usefulness. But, it has caused tremendous capital implosions at 

financial institutions instead. As an investor, I strongly believe that it is far better to 

force financial institutions to supply detailed, supplemental schedules with 

assumptions and methods of pricing securities with proper explanations of various 

pricing conventions.210

Credit Suisse Group – 

We do not believe that fair value accounting was the cause or even a contributing 

factor to the current credit crisis. Fair value accounting did not create the losses, but 

rather reflected the market conditions by initially bringing to light the impact of poor 

lending practices and the resulting effect on the current lack of liquidity and overall 

crisis in the financial markets. Fair value accounting reflects the effects of a 

transaction on an entity's financial statements. It does not, however, drive the 

underlying economic activity.211

 

209 Letter from Hodge. 

210 Letter from Nguyen. 

211 Letter from Credit Suisse. See also David Zion, Amit Varshney & Christopher Cornett, Focusing on Fair Value, 

Credit Suisse Equity Research, June 27, 2008: 

In our view [mark-to-market] accounting is not the problem, it is reflecting an economic reality, asset 

values are falling, the sooner the accounting reflects those losses the better. The real problem was 

overexposure to certain assets, poor risk management, misunderstood mispriced risks and lots of leverage 

(borrowing short and lending or investing long can catch up with you). We would prefer to see the 

financial statements reflect real economic volatility rather than a false sense of stability. 
143

 b. Other Public Statements 

Dane Mott and Sarah Deans, J.P. Morgan Securities Inc. – 

In our July 28, 2008 piece. ... we wrote “blaming fair value accounting for the credit 

crisis is a lot like going to a doctor for a diagnosis and then blaming him for telling 

you that you are sick.” We stand behind this statement. The reality is that fair value 

accounting and enhanced disclosures have helped markets quickly identify where 

problems exist and react to those problems. While we will not deny that at times 

markets have overreacted [sic] to some information, such a reality is a part of human 

nature and likely will persist no matter what accounting is used.212

Dennis Jullens, UBS Investment Research – 

The debate on the financial bail-out plan in the U.S. has also triggered a call to 

suspend fair value accounting as a solution to the current credit crisis. We are 

against a suspension of fair value accounting as it reduces transparency just when 

investors and analysts need it to regain confidence in the financial sector. ...In 

choosing a measurement basis for financial instruments, we defend our preference 

for fair value over historical cost by quoting John Maynard Keynes who stated ‘I 

would rather be vaguely right than precisely wrong’. Suspending fair value 

accounting and allowing banks to recognize their financial assets on the balance 

sheet at an adjusted historical cost number gives a wrong impression of the bank’s 

balance sheet strength. This could even prolong the crisis as neither investors nor 

analysts (nor regulators for that matter) can have any insight into the true financial 

position of entities in the financial sector if financial assets are not recognized on the 

balance sheet at a proxy for their fair value. So despite all the controversy, we argue 

that there is no sensible alternative to the current fair value measurement of financial 

assets and liabilities to assess the net worth of company.213

Bill Mann, The Motley Fool – 

...[S]uspending fair value accounting because the answer is inconvenient is akin to 

firing the weatherman because it's raining. Fair value accounting didn’t cause the 

problems in the financial system. Rather, it pointed them out and highlighted the 

impact of a decade’s worth of poor risk control. Fair value exposed the problem; 

suspending it to allow banks to use alternate methods has the effect of reducing the 

amount of useful information for investors by obscuring the value of large portions 

of banks' balance sheets.214

 

212 Dane Mott & Sarah Deans, Shooting the Messenger, JP Morgan Global Equity Research, September 29, 2008. 

213 Dennis Jullens, Valuation and Accounting Footnotes: Pensions and Fair Value Accounting, UBS Investment 

Research, October 7, 2008. 

214 Bill Mann, How Not to Solve the Credit Crisis, The Motley Fool, October 22, 2008. (available at: 

http://www.fool.com/investing/general/2008/10/22/how-not-to-solve-the-credit-crisis.aspx) 
144

Bridget Gandy, Dina Maher, and Olu Sonola, Fitch Ratings – 

Volatile financial market conditions have caused many reporting financial 

institutions to call for a relaxation of fair value accounting, allowing issuers the 

option of changing from fair value to historical cost accounting. In Fitch Ratings’ 

view, the fundamental and intentional distortions that such unfettered flexibility 

would permit would not engender greater investor confidence in financial reporting 

nor would it foster sound capital markets or sound financial institutions.215

Neri Buckspan, Ron Joas, and Sue Harding, Standard & Poor’s article – 

We support the basic premise that fair value, when coupled with robust disclosure, is 

a relevant basis of accounting for financial assets and liabilities. However, we 

recognize that accounting for assets and liabilities at theoretical market price 

measures may produce results that could mask the underlying economics for certain 

businesses and activities, especially during volatile and uncertain economic and 

market conditions. These inherent limitations underscore the need for financial 

statements to complement fair value measures with additional information about 

uncertainties in the measurement of assets and liabilities.216

Mark LaMonte, Wallace Enman, Wesley Smythe, Donald Robertson, and Jason Cuomo, 

Moody’s Global Credit Research – 

Investors...need to closely analyze the disclosures companies make about the 

financial assets on their balance sheets. Current fair value amounts are critical in 

the assessment of a firm’s liquidity position. Additional disclosures firms may 

make about their estimates of the longer-term “economic value” may also be 

valuable to investors in assessing the long-term health and future prospects of 

those firms. These disclosures should be used carefully. They are most valuable 

when accompanied by thorough sensitivity analysis related to key assumptions 

underlying the estimates of economic value.217

 c. Observations 

From these comments and others received during the course of this study, most investors 

and other users of financial reports who provided input indicated a view that fair value 

accounting transparently reflects, under current economic conditions, the value of assets and 

liabilities of the companies in which they invest. Most indicate that suspending fair value 

 

215 Bridget Gandy, Dina Maher & Olu Sonola, Fair Value Accounting: Is It Helpful in Illiquid Markets?, Fitch 

Ratings Accounting Research Special Report, April 28, 2008. 

216 Neri Bukspan, Ron Joas & Sue Harding, Is it Time to Write Off Fair Value?, Standard & Poor’s Ratings Direct, 

May 27, 2008. 

217 Mark LaMonte, Wallace Enman, Wesley Smythe, Donald Robertson & Jason Cuomo, How the Global Credit and 

Economic Crises are Affecting Accounting and Financial Reporting Issues - An Overview of Key Implications From 

a Credit Perspective, Moody’s Global Credit Research, December 2008. 
145

accounting would result in a loss of information and investor confidence. However, these 

comments also clearly indicate that fair value reporting can pose challenges, particularly in 

the absence of active markets. Users also express the need to supplement fair value 

accounting with robust disclosure of the underlying assumptions and sensitivities, 

particularly when fair value estimates are necessary in the absence of quoted prices. In 

addition, some question the usefulness of fair value reporting when management does not 

use internal fair value metrics to make operational decisions. Nonetheless, there is little 

evidence to suggest investors and other users generally believe an alternative to fair value, 

such as amortized cost, would be a superior approach. 

2. Common Themes in Individual Analyst Reports on Fair Value 

Measurements 

To supplement the summary of publicly stated investor and user views on fair value accounting, 

the Staff reviewed 106 individual analyst reports released between December 1, 2007 and 

December 1, 2008. These reports were obtained through a search of the Thomson ONE Banker 

database. Search parameters were selected to focus on reports of institutions in the financial 

services sector containing the expressions “fair value” or “mark-to-market.” 

The purpose of this review was to identify specific commentary in the analysts’ work product 

(i.e., the reports) regarding the impact of fair value accounting on the quality of information 

considered in the context of actual analysis by users of financial information. As a result of its 

review, the Staff observed the following common themes: 

• Several analysts provided commentary that fair value accounting for brokers tended to 

accelerate the recognition of losses compared to banks and that, as a result, brokers were 

generally expected to outperform banks in the early stages of recovery. 

• A large number of analysts predicted additional losses in future periods for assets subject to 

fair value accounting. 

• Several analysts commented that while their analyses and conversations with company 

management provided some comfort as to the reasonableness of certain fair value 

adjustments each period, they recognized the “softness” of fair value estimates means that 

financial statement users cannot independently confirm the accuracy of such figures. 

• A number of analysts appeared to discount the value of gains recognized in income caused 

by declines in a company’s own credit risk related to debt carried at fair value. One analyst 

characterized this as “an aggressive approach” because the gain wasn’t expected to be 

monetized at a future date, but it nonetheless had the effect of offsetting losses on the 

company’s investment portfolio. 

• Some analysts appeared to use fair value information to benchmark particular companies 

against their competitors, speculating on what differential valuation results say about the 

ultimate collection of results of comparable portfolios of financial assets. 
146

• A limited number of analysts included summaries of proprietary valuations to support their 

ultimate investment recommendations. Certain valuation techniques reversed the current 

period’s income impact for non-cash gains and losses, including the effect of financial assets 

carried at fair value, in order to prepare a projection of future cash flows. The Staff 

understands analysts commonly incorporate estimates of future cash flows into valuation 

models to reflect the anticipated disposition of the financial asset or liability that generated 

the non-cash gain or loss. Alternatively, the current fair value of the financial asset or 

liability could be added to the result of the discounted cash flow analysis in lieu of estimating 

the cash received or paid at disposal. 

Beyond these observations, there was generally no additional commentary on the impact of fair 

value on the quality of information available to the analysts. As a result, the Staff did not 

observe any significant or recurring inconsistencies between the publicly stated views noted 

above compared to individual analyst reports. 

B. Views Presented by Participants at Recent SEC Fair Value Roundtables 

The SEC has hosted three public roundtables in 2008 on fair value accounting. The first was 

held on July 9, 2008, prior to the mandate for this study, to facilitate an open discussion of the 

benefits and potential challenges associated with existing fair value accounting and auditing 

standards. Two additional roundtables on fair value accounting were held in connection with 

this study, the first on October 29, 2008, and the second on November 21, 2008. These 

roundtables focused on several issues related to fair value accounting, including: the usefulness 

of fair value accounting to investors and regulators; the effects of fair value accounting on 

financial reporting by financial institutions; the potential market behavior effects from fair value 

accounting; and whether aspects of current accounting standards can be improved. Panelists at 

the roundtables included investors, issuers, auditors, academics, former regulators, and others 

with experience in financial institutions’ fair value accounting practices. The themes of each 

roundtable are summarized below. 

1. July 9 Roundtable218

a. Usefulness of Fair Value and Related Disclosures in Current 

Market Conditions 

Investors indicated that fair value is the most relevant measurement attribute for financial 

instruments in the current market environment. They recommended that disclosures related to 

fair value estimates be enhanced to include more information on the methods used, along with 

the significant assumptions and sensitivity around those assumptions. However, one preparer 

expressed concerns that more disclosure would result in “disclosure overload.” Additionally, 

both investors and preparers discussed the fact that fair value disclosures are scattered 

throughout financial statements and would be more useful if they were consolidated into one 

location. 

 

218 See http://www.connectlive.com/events/secroundtable070908/ for archived webcast. See Appendix B for a 

listing of roundtable participants. 
147

Preparers of financial statements held mixed views about the usefulness of fair value accounting 

in current market conditions. Preparers that manage their businesses based on fair values, such 

as investment banks and mutual funds, indicated that fair value for financial instruments is 

always the most relevant measure. Preparers whose business activities include managing 

financial assets based on a longer-term profit expectation, for instance insurance companies and 

commercial banks, questioned the relevance of measuring securities based on current illiquid 

prices when those prices do not reflect the company’s ultimate cash flow expectations. 

b. Application of Fair Value Accounting 

Preparer views also varied as to the difficulty of developing fair value estimates in the current 

environment. One preparer indicated that measuring fair value simply requires additional effort 

when illiquid markets exist, while other preparers and auditors expressed the view that applying 

the concepts in SFAS No. 157 under current market conditions is challenging. Concerns were 

raised that SFAS No. 157 lacks sufficient application guidance. Specifically, some indicated that 

interpretive guidance would be useful to assist auditors and preparers in answering the following 

questions: 

• What is an active market? 

• What are the characteristics of illiquid markets? 

• How do you determine when a sale is distressed versus an orderly transaction? 

• What represents sufficient evidence for an auditor? 

Preparers also expressed concern over the use of third party service providers, such as brokers 

and pricing services, to develop estimates of fair value – specifically that they do not reflect the 

“true market price” of an asset and that the quotes may contain bias, and thus not fully reflect the 

views of market participants. 

Although not directly related to measuring fair value, panelists also discussed difficulties 

associated with determining when declines in fair value are other-than-temporary, which lead to 

impairment charges in the income statement. One preparer stated that current interpretations of 

how to analyze declines in the fair value of securities classified as “AFS” under SFAS No. 115 

are overly burdensome. The same preparer expressed a belief that the guidelines for recognizing 

other-than-temporary losses are negatively affecting the ability of some insurance companies to 

properly manage their investment portfolios. 

c. Market Behavior Effects of Fair Value Accounting 

Most of the panelists indicated that they do not share the view that fair value accounting is procyclical. Panelists stressed the importance of accounting being neutral and its objective of 

reflecting economic reality in the marketplace. However, some preparers expressed concern that 

fair value accounting may influence management behavior. Specifically, preparers indicated that 

companies may avoid investing in certain types of assets if they anticipate difficulty in 

estimating the assets’ fair value in future periods. 
148

d. Impact of Non-Performance Risk on Fair Value of Liabilities 

The panelists expressed a diversity of views as to whether including changes in a company’s 

own credit risk in fair value estimates for liabilities is consistent with the underlying economics. 

Some argued that decreases in a company’s liabilities stemming from its own credit standing do, 

in fact, reflect actual economics. As a result, they believe reporting an unrealized gain in the 

income statement is appropriate. However, when the same company’s assets are not measured at 

fair value each period, there are no offsetting losses recorded. Consequently, other panelists 

expressed concern that this lack of symmetry may confuse readers of financial statements. 

Some preparers expressed other concerns about using fair value to measure a liability when 

management does not intend to pay the entire principal until maturity. They questioned the 

usefulness of temporary gains related to declines in fair value because they are not ultimately 

realized in cash. 

2. October 29 Roundtable219

a. Usefulness of Fair Value Accounting 

Those panelists who generally opposed the use of fair value accounting expressed a number of 

concerns regarding its use, including the view that fair value understates the “true economic 

value” of financial instruments when markets are depressed. Opponents also asserted that an 

inconsistency exists between the accounting model and the business model in some cases. For 

example, some community banks originate loans with the expectation of holding and servicing 

them until maturity. Consequently, these banks and their owners may find current values less 

relevant for loans they expect to hold for years. Others perceive a conflict between the exit price 

notion in SFAS No. 157 (i.e., the amount received upon sale of an asset) and the idea that the 

reporting entity is a going concern that expects to continue operations indefinitely. Additionally, 

one panelist indicated the consequences of fair value accounting were so negative that they 

impeded a planned acquisition of another bank. This panelist indicated that certain loans would 

have been valued at only 20% to 30% of par (the current fair value of the loans) in the 

acquisition, lowering the acquiring bank’s regulatory capital to an unacceptably low level. As a 

result, management decided not to pursue the transaction. 

Panelists who support fair value accounting indicated that it provides investors with the most 

relevant information about financial instruments and serves to increase both transparency and 

consistency in financial reporting. However, they also acknowledged challenges in its 

application. 

 

219 See http://www.connectlive.com/events/secroundtable102908/ for archived webcast. See Appendix B for a 

listing of roundtable participants. 
149

b. Market Behavior Effects of Fair Value Accounting 

Many panelists stated that they did not believe fair value accounting was the cause or a 

contributing factor to the current global economic crisis. These panelists noted that accounting 

information is intended to report economic activity, but does not cause it. 

Other panel members disagreed, stating their view that fair value accounting has significantly 

compounded the current global economic crisis and has served to unnecessarily diminish the 

regulatory capital of many financial institutions. They assert that when asset prices decline and 

liquidity is reduced, banks are forced to sell their investments or raise capital (due to the 

interaction of regulatory capital requirements that are based on the value of their assets). If bank 

portfolios are marked-to-market, their capital position deteriorates, which, in turn, causes more 

asset sales and further depresses asset prices. Selling creates a “liquidity spiral” which results in 

bank failures. As a result, banks are forced to tighten their lending practices, thus reducing the 

availability of credit generally. 

Aside from these disagreements, one general consensus was a belief that fair value information is 

relevant to investors and should be communicated in one fashion or another. However, panelists 

did not agree as to the best way to present this information. Some preferred disclosing fair value 

information only in the footnotes to the financial statements or in MD&A, while others indicated 

recording fair values in the financial statements themselves is more appropriate. 

c. Application of Fair Value Accounting 

Panelists also discussed the role of judgment in determining fair value estimates, particularly in 

situations in which markets are illiquid or inactive. Some asserted that the prospect of “secondguessing” and potential legal exposure in many cases deter the use of judgment. These factors 

can also impede the increasingly comprehensive disclosures sought by some users (e.g., 

sensitivity analyses) including those suggested by the Staff in the “Dear CFO” letters that were 

issued in March and September of 2008.220 There was general agreement among participants 

that the exercise of judgment is required in order to appropriately estimate fair value, particularly 

when faced with inactive markets. 

d. Interaction with Regulatory Capital Requirements 

Another topic that generated a significant amount of discussion was the interrelationship between 

regulatory capital requirements and accounting information generated by following U.S. GAAP. 

Panelists generally agreed that fair value standards used for the purpose of providing information 

to investors should not be suspended or overridden in an attempt to address liquidity or capital 

standards for bank regulatory purposes. Participants expressed the view that concerns about the 

impact of fair value accounting “requiring” an entity to sell assets and / or raise additional capital 

are inaccurate. A number of panelists observed that accounting standards are established to 

provide information (they are the “messenger”); they do not require an entity to sell assets or 

 

220 See March 2008 letter available at http://www.sec.gov/divisions/corpfin/guidance/fairvalueltr0308.htm and 

September 2008 letter available at http://www.sec.gov/divisions/corpfin/guidance/fairvalueltr0908.htm. 
150

raise additional capital. Capital adequacy standards are established by safety and soundness 

regulators. Thus, if concerns exist surrounding the use of fair value information for capital 

purposes, these participants suggested such concerns should not be addressed by changing the 

information provided to investors. 

 e. Potential Changes to Financial Statement Presentation 

Lastly, panelists discussed possible changes to the presentation of fair value measurements in the 

financial statements. One alternative included presenting changes in fair value of investments in 

securities due to credit impairment separately from changes due to other factors, such as changes 

in liquidity. Under this approach, a company would only report changes in fair value caused by 

credit impairments in net income, with all other changes reported directly through equity (i.e., 

OCI) on the face of a statement of comprehensive income. While this alternative generated 

interest across the panel, one participant expressed significant operational concerns about the 

ability to disaggregate the components of a fair value measurement and envisioned future 

disagreements between preparers and auditors on this point. 

3. November 21 Roundtable221

a. Usefulness of Fair Value Information 

Panelists generally agreed that fair value accounting under SFAS No. 157 is not the root cause of 

the current global economic crisis and that a suspension or repeal of fair value accounting would 

not strengthen investor confidence in the current environment. Panelists indicated that regulators 

should look beyond SFAS No. 157 to address any pro-cyclical effects on regulatory capital 

requirements for financial institutions. Most panelists agreed fair value accounting and 

regulatory capital rules are distinct issues that should be considered separately, echoing the 

comments of participants in the prior roundtables. In addition, the panel expressed strong 

support for independent standard-setting at the Boards, noting that the process needs to be free of 

political or regulatory intervention. However, most members of the panel also agreed on two 

related aspects of fair value accounting needing improvement: the application of existing 

accounting standards that address whether certain assets are impaired, and the preparation of fair 

value estimates in the absence of quoted prices in active markets. 

b. Asset Impairment Guidance and Estimates of Fair Value 

Panelists generally agreed that standard-setters should revisit OTTI guidance under current U.S. 

GAAP. One suggestion was made to harmonize the guidance for impairment of investments in 

debt securities under SFAS No. 115 with the guidance for loan impairments under SFAS No. 

114. A second idea was to distinguish the credit loss component of an impairment charge from 

other changes in fair value, such as the effect of liquidity discounts or premiums. Certain 

investors and auditors suggested an approach in which credit losses (either expected or incurred) 

on debt securities would be recognized each period in income, while other changes in the fair 

 

221 See http://www.connectlive.com/events/secroundtable112108/ for archived webcast. See Appendix B for a 

listing of roundtable participants. 
151

value of an investment would be recorded in equity (i.e., OCI).222 The credit loss could be 

calculated on the basis of changes in expected cash flows similar to the provisions of SFAS No. 

114. 

As an alternative, a number of preparers also suggested that investments that are not held for 

trading purposes should be carried at amortized cost so that only losses associated with credit 

would reduce earnings per share. Supplemental information about the fair value of the 

investment could be disclosed in the notes to the financial statements.223 They indicated their 

view that charges in OCI caused by illiquid markets inappropriately distort equity. In turn, this 

impacts the capital levels of financial institutions. 

c. Financial Statement Presentation 

Panelists agreed that improved income statement presentation of fair value measurements would 

enhance the transparency and usefulness of financial statements for investors and other users. 

Specifically, under today’s standards, the components of changes in fair value, including credit 

events and liquidity fluctuations, are not presented separately. It was noted that improved 

presentation is consistent with a current project under joint development between the Boards, 

which is scheduled to be completed by 2011. 

d. Additional Disclosures 

Panelists generally agreed on the need for more comprehensive disclosures. Suggestions 

included sensitivity analyses for fair value estimates, forward-looking information related to the 

expected value of certain investments at future dates (e.g., maturity), as well as detailed 

discussions of the valuation techniques and inputs used by management. Certain panelists 

suggested that additional disclosure requirements should be enacted before 2008 year-end 

financial reporting is completed. These panelists also indicated that if the SEC and / or the 

FASB do not envision providing such guidance, then they should consider making their 

intentions known in order to manage the expectations of preparers and auditors. 

C. Recent Advisory Committee Recommendations Related to Fair Value 

Measurements 

Recently, two separate federal advisory committees commented on aspects of fair value 

accounting, providing recommendations on improving the usefulness of fair value for investors. 

Educational efforts were a common point among the recommendations in each committee’s 

report. 

 

222 For example, assume a debt investment previously was carried at $100, but that management concluded it was 

impaired by $60. Of this amount, assume $10 is determined to represent credit losses (or losses where it is probable 

that cash flows will not be received), while the remaining $50 is attributed to other factors, including the effect of a 

general decline in liquidity. In this situation (ignoring taxes), the asset would be reduced to $40 on the balance 

sheet, income would be charged for $10, and equity (accumulated OCI) would be lessened by $50. 

223 Adapting the previous example for this scenario, a $100 asset would be reduced to $90 on the balance sheet for 

the effect of credit losses, and income would be charged for $10. No other entries in the primary financial 

statements would be recorded. The footnotes would disclose the investment’s current fair value was only $40. 
152

In October 2008, the Treasury Department’s Advisory Committee on the Auditing Profession 

(the “Treasury Committee”) issued its final report.224 In the context of higher education for 

accounting students, the Treasury Committee recommended changes to ensure that degree 

requirements and CPA exam content meet the challenges of ongoing market developments and 

investor needs. These included the increasing use of IFRS and expanded fair value 

measurements in financial reports. Similarly, the Treasury Committee recommended that 

organizations, such as the AICPA and the American Accounting Association, meet with 

commercial content providers and encourage them to update their materials promptly to reflect 

recent developments, again singling out the increasing use of IFRS and expanded fair value 

reporting as topical improvements. 

In August 2008, CIFiR issued its final report.225 CIFiR explored fair value accounting in some 

detail given CIFiR’s dual-mandate to improve the usefulness of financial reports for investors 

and also to reduce the complexity in financial reporting generally.226 This resulted in a number 

of recommendations related to the “mixed-attribute model” in U.S. GAAP, including educational 

improvements. 

CIFiR recommended a long-term goal for the FASB to develop a consistent approach for 

determining which measurement attribute should apply to different types of business activities. 

In particular, it should address whether and when fair value should be used. This concept is 

referred to as the “measurement framework.” 

CIFiR also advocated a number of steps in the near-term to improve the clarity of financial 

statements for investors. First, CIFiR recommended a “judicious approach” in expanding the use 

of fair value in financial reporting until a number of practice issues are better understood and 

resolved and the FASB completes its measurement framework. CIFiR identified a number of 

practical challenges to fair value reporting. These include: (1) the uncertainty of some estimates 

that are developed in the absence of quoted prices and attendant concerns about these estimates 

being “second-guessed;” (2) demands for ever-increasing detailed accounting guidance to 

develop such estimates; (3) the lack of a single set of authoritative generally accepted valuation 

standards like U.S. GAAP; and (4) the absence of a comprehensive system to ensure continuing 

professional education and certification requirements for valuation professionals.227

Next, CIFiR proposed a consistent presentation of amounts in the financial statements based on 

their distinct measurement attributes, grouped by meaningful categories.228 The intent was to 

 

224 See Treasury Committee, Final Report, October 6, 2008. (available at: http://www.ustreas.gov/offices/domesticfinance/acap/docs/final-report.pdf) 

225 See CIFiR Final Report. 

226 It should be noted CIFiR did not take a position as a supporter or opponent of fair value accounting. It stated, 

“We did not attempt to resolve the ongoing debate about what should be accounted for at fair value versus some 

other basis. Rather, we have been focused on explaining better to investors the components of the mixed-attribute 

model.” (CIFiR Final Report, at page 29, footnote 55). 

227 See CIFiR Final Report, at pages 28-29. 

228 See CIFiR Final Report, at page 28. Meaningful categories might be, for instance, the operating, investing, and 

financing sections of financial statements. 
153

make subtotals of individual line items in the statements more informative, and is consistent with 

a current project under joint development by the Boards.229 This project includes a reconciliation 

of the statements of income and cash flows by major classes of measurement attributes to help 

investors analyze income. A detailed example of this reconciliation, as proposed by CIFiR, is 

provided in Appendix C. 

In addition to recommending improvements to the presentation of financial statements, CIFiR 

also recommended enhancing the disclosure of different measurement attributes. Such 

disclosures should enable investors to better understand the related risks and uncertainties, such 

as sensitivity analyses to depict the volatility of fair value estimates. 

Lastly, CIFiR addressed the importance of education: 

Before expanding the role of fair value in financial reporting, we believe standardssetters and regulators should develop and implement a plan to strengthen the 

infrastructure that supports its use. Specifically, educational seminars may be necessary 

to better inform investors about the characteristics of fair value reporting. Likewise, 

preparers and auditors would benefit from ongoing training in basic valuation matters to 

reduce dependence on valuation specialists. Finally, the curricula in undergraduate and 

graduate accounting programs, as well as the CPA exam, will need to incorporate 

concepts of valuation theory and practice. We recognize a plan like this (as well as its 

execution) will require a coordinated effort among all constituents because each party 

shares an interest in accurate and reliable financial reports. In other words, standardssetters, preparers, auditors, regulators, and investors all have a role in fair value 

reporting. As each party gains experience with fair value information, it should be 

shared and considered by others in the educational effort to facilitate system-wide 

improvement.230

In short, both the Treasury Committee and CIFiR recognized the importance of all financial 

reporting constituents becoming better acquainted with fair value theory and practice. Without 

necessarily supporting or opposing mark-to-market accounting, it appears the committees 

believed communication between companies and financial statement users could be enhanced by 

encouraging a shared understanding about fair value, the economic information it conveys about 

business transactions, and its limitations. 

D. Prior Published Staff Views on Fair Value Accounting 

Two previous Congressional studies by Staff that considered ways to improve the quality of 

financial reporting to investors addressed fair value accounting. In the 2005 study on off-balance 

sheet activity and special purpose entities, the Staff addressed fair value accounting as follows: 

 

229 FASB Financial Accounting Series, No. 1630-100 (available at: 

http://fasb.org/draft/DP_Financial_Statement_Presentation.pdf); and IASB Preliminary Views on Financial 

Statement Presentation. (available at: http://www.iasb.org/NR/rdonlyres/92028667-6118-496E-B0FE97F829858B5D/0/DPPrelViewsFinStmtPresentation.pdf ) 

230 CIFiR Final Report, at page 21. 
154

The Staff recommends the continued exploration of the feasibility of reporting all 

financial instruments at fair value. Supporters of greater use of fair values on the 

balance sheet argue that the most useful information is that which reflects the current 

values of assets and obligations. Fair value accounting for all financial instruments 

also would appear to have benefits in terms of reduced complexity (for example, by 

eliminating the need for hedge accounting and its attendant documentation and 

effectiveness testing requirements, in many instances), more understandability, and 

less motivation to structure transactions so as to achieve certain accounting 

treatments. Of course, some have expressed significant concerns with requiring fair 

value accounting for all financial instruments, such as the potential manipulability 

and degree of difficulty in auditing some fair values. However, in light of the 

potential benefits, the Staff believes that methods should be sought to eliminate the 

obstacles to this treatment.231

In addition, as part of its 2003 study on principles-based accounting standards, the Staff noted, 

“it appears likely that in moving to a more objectives-oriented regime, the FASB will issue more 

standards that rely on fair value as the measurement attribute. If so, it would be imperative that 

accounting professionals be trained in valuation theory and techniques.”232

E. Abstract of Available Academic Studies Addressing the Impact of Fair Value 

Accounting on the Quality of Information Available to Investors 

In addition to the above survey of investor and user views and other input received, the Staff also 

undertook a review of academic studies that have evaluated the usefulness of fair value 

information to investors. Many of these academic studies use large-scale samples of firms or 

investors and, thus, may not be subject to any small sample bias that may exist from observing 

only publicly submitted individual views. However, consistent with the survey above, the results 

of this body of academic research support the view that fair value information increases the 

quality of information available to investors. 

In general, “value relevance” studies examine whether stock prices are associated with 

recognized fair value amounts and / or reported fair value disclosures. The results from these 

studies show that firms’ equity values are significantly associated with both recognized fair value 

amounts and fair value disclosures. Most of the studies conducted using U.S. data examine the 

association between stock prices and either recognized or disclosed fair values for financial 

instruments. These studies also tend to focus on samples of banks or insurance companies (e.g., 

the value relevance of fair value disclosures made under SFAS No. 107 for banks).233 

 

231 Off-Balance Sheet Report. 

232 Principles-Based Accounting Study. 

233 See, e.g., Mary E. Barth, William H. Beaver & Wayne R. Landsman, Value-Relevance of Banks’ Fair Value 

Disclosures under SFAS No. 107, 71 The Accounting Review 4 (1996), 513-537; Elizabeth A. Eccher, K. E. 

Ramesh, S. Ramu & S. Thiagarajan, Fair Value Disclosures by Bank Holding Companies, 22 Journal of Accounting 

and Economics (1996), 79-117; and Karen Nelson, Fair Value Accounting for Commercial Banks: An Empirical 

Analysis of SFAS No. 107, 71 The Accounting Review 2 (1991), 161-182. 
155

The evidence of these studies also indicates that different fair value amounts are not uniformly 

informative or useful to investors (potentially due to differences in the real or perceived 

reliability of the estimates). Evidence shows that fair values obtained from actively traded 

markets are more reliably associated with share prices than fair value estimates obtained from 

illiquid markets or internal model estimates. For example, research using data for commercial 

banks and property-casualty insurers indicates that fair values for equity investments in U.S. 

Treasury securities are related to share price, but fair values for securities with less liquid 

markets (e.g., corporate bonds) are not.234 Similarly, early evidence regarding the usefulness of 

fair value disclosures made under SFAS No. 157 indicates that while Level 1 and 2 estimates 

(i.e., reflecting quoted prices in active markets for the identical asset or liability, and other 

observable inputs for the asset or liability, respectively) are value relevant to investors, Level 3 

estimates are much less value relevant to investors.235 

The results of these “value relevance” studies also provide support for the view expressed by 

investors that additional disclosures would be most useful in the case of fair values derived from 

illiquid markets or model estimates.236 Specifically, the lower degree of “value relevance” of fair 

values derived from illiquid markets or model estimates supports the idea that additional 

disclosures would be most useful in the case of these types of fair values. While Level 3 

estimates may be less reliable than Level 1 or 2 estimates, further disclosures regarding the 

nature of the assumptions underlying Level 3 fair value estimates may help lessen the degree to 

which Level 3 disclosures (as managerial estimates) are potentially less informative to investors 

than Level 1 or 2 disclosures.237 

 

234 See, e.g., Mary E. Barth, Fair Value Accounting: Evidence from Investment Securities and the Market Valuations 

of Banks, 69 The Accounting Review 1 (1994), 1-25; and Kathy Petroni & James Wahlen, Fair Values of Equity 

and Debt Securities and Share Prices of Property-Liability Insurers, 62 Journal of Risk and Insurance 4 (1995), 719-

737. 

235 See Chang J. Song, Wayne Thomas & Han Yi, Value Relevance of FAS 157 Fair Value Hierarchy Information 

and the Impact of Corporate Governance Mechanisms. Draft manuscript, University of Oklahoma. (2008) (“Song, 

et al.”). (available at: http://ssrn.com/abstract=1198142) The evidence in this study is early in the sense that it is 

based upon data from the first to third quarters of 2007 and uses a sample of firms that chose to adopt SFAS 157 

early. 

236 See Stephen G. Ryan, Fair Value Accounting: Understanding the Issues Raised by the Credit Crunch (White 

Paper) Council of Institutional Investors (2008). 

237 See Wayne Landsman, Is Fair Value Accounting Information Relevant and Reliable? Evidence from Capital 

Market Research, Accounting and Business Research (Special Issue) (2007), 19-30; and Stephen G. Ryan, 

Accounting in and for the Subprime Crisis, The Accounting Review, (Forthcoming) (2008). 
156
157

V. Process Used by the FASB in Developing Accounting 

Standards 

This section of the study discusses the FASB governance and processes that result in the 

accounting standards U.S. public companies apply. This portion of the study is primarily based 

on publicly available information from the FASB and its parent organization, the Financial 

Accounting Foundation (“FAF”).238

An accounting standard-setting process is the foundation of a financial reporting system. In turn, 

this system is essential to the efficient functioning of the economy because investors, creditors, 

and others rely on credible, transparent, and comparable financial information for purposes of 

providing and allocating capital. 

A. Background and Mission 

As noted in Section I.B, the Commission in the 2003 Policy Statement recognized the financial 

accounting and reporting standards of the FASB as “generally accepted” for purposes of the 

federal securities laws. The 2003 Policy Statement also indicates that the Commission, in its 

oversight capacity, has determined that the FAF and the FASB satisfy the requirements in 

Section 108 of the Sarbanes-Oxley Act. Section 108 establishes criteria that must be met in 

order for the work product of an accounting standard-setting body to be recognized as “generally 

accepted.” Accordingly, the SEC may recognize a standard-setting body that: 

• is organized as a private entity; 

• has, for administrative and operational purposes, a board of trustees serving in the public 

interest, the majority of whom are not, concurrent with their service on such board, and have 

not been during the two-year period preceding such service, associated persons of any 

registered public accounting firm; 

• is funded as provided in Section 109 of the Sarbanes-Oxley Act; 

• has adopted procedures to ensure prompt consideration, by majority vote of its members, of 

changes to accounting principles necessary to reflect emerging accounting issues and 

changing business practices; and 

• considers, in adopting accounting principles, the need to keep standards current in order to 

reflect changes in the business environment, the extent to which international convergence on 

high quality accounting standards is necessary or appropriate in the public interest and for the 

protection of investors.239

 

238 Unless otherwise indicated, the content in Section V is reproduced or adapted from the websites of the FASB 

(www.fasb.org) and the FAF (http://www.fasb.org/faf/index2.shtml). Further details about the FASB’s governance 

and process are available on these websites. 

239 See Section 19(b)(1) of the Securities Act, as amended by Section 108 of the Sarbanes-Oxley Act. 
158

The mission of the FASB is to establish and improve standards of financial accounting and 

reporting for the guidance and education of the public, including issuers, auditors, and users of 

financial information. The FASB develops broad accounting concepts as well as standards for 

financial reporting. It also provides guidance on implementation of standards. Concepts are 

useful in guiding the FASB in establishing standards and in providing a frame of reference, or 

conceptual framework, for resolving accounting issues. The FASB’s work on both concepts and 

standards is based on research aimed at gaining new insights and ideas. Research is conducted 

by the FASB staff and others, including foreign national and international accounting standardsetting bodies. The FASB’s activities are open to public participation and observation under the 

“due process” mandated by the Articles of Incorporation and By-Laws of the FAF and Rules of 

Procedure of the FASB. The FASB looks to the following precepts in the conduct of its 

activities: 

• To be objective in its decision-making and to ensure, insofar as possible, the neutrality of 

information resulting from its standards; 

• To weigh carefully the views of its constituents in developing concepts and standards; 

• To promulgate standards only when the expected benefits exceed the perceived costs; 

• To bring about needed changes in ways that minimize disruption to the continuity of 

reporting practice; 

• To review the effects of past decisions and interpret, amend or replace standards in a timely 

fashion when such action is indicated; and 

• To follow an open, orderly process for standard-setting that precludes placing any particular 

interest above the interests of the many who rely on financial information. 

B. Governance and Structure 

The FASB is part of a structure that is independent of other business and professional 

organizations. However, the FASB is subject to oversight by the FAF, which is an independent, 

private-sector organization incorporated to operate exclusively for the charitable, educational, 

scientific, and literary purposes within the meaning of Section 501(c)(3) of the Internal Revenue 

Code. The FAF, subject to SEC oversight, is responsible for selecting the members of the FASB 

and its advisory council (see below) and exercises general oversight, with the exception of the 

FASB’s resolution of technical accounting issues. 

In addition, the FASB consults with the Financial Accounting Standards Advisory Council 

(“FASAC”) as to technical issues on the FASB’s agenda, project priorities, matters likely to 

require the attention of the FASB, selection and organization of task forces, and such other 

matters as may be requested by the FASB or its Chairman. At present, FASAC has more than 30 

members who are broadly representative of preparers, auditors, and users of financial 

information. 
159

Pursuant to the Sarbanes-Oxley Act, the FASB is independently funded by an “annual 

accounting support fee” assessed and collected against issuers to fund recoverable expenditures 

of the FASB.240

Details regarding individuals and organizations comprising the FASB and the FAF are available 

in Appendix D. 

C. Standard-Setting Process 

Actions of the FASB have an impact on many organizations within its constituency. 

Accordingly, the FASB follows a due process that is open to public observation and 

participation. These procedures are used for major agenda projects, some of which may not be 

necessary for application and implementation projects. 

The primary outcome of the FASB’s work is authoritative standards of financial accounting and 

reporting, authoritative guidance on the implementation of those standards, and broad accounting 

concepts. Those standards are often referred to as generally accepted accounting principles, or 

GAAP. In addition to the effect of the 2003 Policy Statement, which recognizes the standards as 

“generally accepted” for purposes of the federal securities laws, the standards also are considered 

to be “generally accepted” by virtue of the procedures used to establish them (including 

extensive due process), not because they necessarily represent a consensus (or generally 

accepted) view of issuers, auditors, users, or any other constituent group. The procedures the 

FASB uses to establish U.S. GAAP are set out in several documents including the Certificate of 

Incorporation and By-Laws of the FAF, the Rules of Procedure of the FASB, and the FASB’s 

more detailed policy manual. 

Initially, the FASB receives requests or recommendations for possible projects and 

reconsideration of existing standards from various sources. The FASB staff then, after 

consultation with other members of the Board, summarizes the information it receives and 

discusses its findings with the FASB’s Chairman who decides whether to add the project to its 

agenda. If the project is undertaken, the FASB will deliberate the various issues identified and 

analyzed by the staff at one or more public meetings. To convey its views, the FASB will issue 

one or more due process documents, which may be an exposure draft of a proposed accounting 

standard or may be a more exploratory document such as a discussion paper. These initial due 

process documents are issued for public comment to obtain feedback on the direction of the 

project. Depending on the circumstances surrounding the project, the FASB may hold a public 

roundtable meeting on the due process document(s). Afterward, the staff analyzes comment 

letters, public roundtable discussion, and any other information in order for the FASB to 

redeliberate the proposed provisions at public meetings. Finally, the FASB may issue additional 

due process documents, proceed to issuing a SFAS or FASB Interpretation (“Interpretation”) by 

simple majority vote, or decide not to continue with the project. 

These steps are described in greater detail below. 

 

240 See 15 U.S.C. 7219. 
160

1. How Topics Are Added to the FASB’s Technical Agenda and 

Developed 

The FASB receives many requests for action on various financial accounting and reporting 

topics from all segments of its constituency, including the SEC and its Staff.241 The auditing 

profession is sensitive to emerging trends in practice and, consequently, is a frequent source of 

requests. Requests for action include both new topics and suggested review or reconsideration of 

existing pronouncements. 

The FASB is alert to trends in financial reporting through observation of published reports, 

liaison with interested organizations, and discussions with the EITF (see below). In addition, the 

FASB staff receives many technical inquiries which often provide evidence that a particular 

topic, or aspect of an existing pronouncement, has become an issue. The FASB also is alert to 

changes in the financial reporting environment that may be brought about by new legislation or 

regulatory decisions. 

Along with FASAC, the FASB’s User Advisory Council and Small Business Advisory 

Committee also serve as resources to the FASB, both in formulating its technical agenda and in 

advising on specific agenda projects. Additionally, the ITAC is a standing resource to the FASB 

and its staff that provides technical accounting advice, from the investors’ perspective, on current 

projects. The ITAC also will identify critical accounting and financial reporting deficiencies that 

require the FASB’s attention and will propose new items to be added to the technical agenda, 

both major projects and technical application and implementation activities. 

The FASB also utilizes other organizations and groups for advice and information on various 

matters, including its agenda. Among the groups with which liaison is maintained are the 

Accounting Standards Executive Committee and the Auditing Standards Board of the AICPA, 

the PCAOB, the IASB, and the appropriate committees of such organizations as the CFA 

Institute, Financial Executives International, and Institute of Management Accountants. 

To aid in the decision-making process, the FASB has developed a list of factors that are the basis 

for evaluating agenda proposals:242

 

241 For example, the 2003 Policy Statement provides (footnotes omitted): 

The FASB, in its role of “assist(ing) the Commission in fulfilling the requirements of the Securities 

Exchange Act,” should provide timely guidance to public companies, accounting firms, regulators and 

others on accounting issues that the Commission considers to be of immediate significance to investors. 

The Commission and its staff, however, do not prohibit the FASB from also addressing other topics, and do 

not dictate the direction or outcome of specific FASB projects so long as the conclusions reached by the 

FASB are in the interest of investor protection. We expect that the Commission staff will refer issues to the 

FASB or one of its affiliated organizations when those issues may warrant new, amendments to, or formal 

interpretations of, accounting standards. We also expect that the FASB will address such issues in a timely 

manner. On those occasions when the FASB may determine that consideration of the issue is not advisable 

or that the issue cannot be resolved within the time frame acceptable to the Commission, we expect that the 

FASB promptly will notify the Commission or its staff, provide us with its views regarding an appropriate 

resolution of the issue, and diligently work with us and our staff to ensure the protection of investors from 

misleading or inadequate accounting or disclosures. 

242 In addition, as set forth the 2003 Policy Statement, the Commission expects the FASB to: 
161

• Pervasiveness of the Issue – the extent to which an issue is troublesome to users, preparers, 

auditors, or others; the extent to which there is diversity of practice; and the likely duration of 

the issue, i.e., whether transitory or likely to persist; 

• Alternative Solutions – the extent to which one or more alternative solutions that will 

improve financial reporting in terms of relevance, reliability, and comparability are likely to 

be developed; 

• Technical Feasibility – the extent to which a technically sound solution can be developed or 

whether the project under consideration should await completion of other projects; 

• Practical Consequences – the extent to which an improved accounting solution is likely to be 

acceptable generally, and the extent to which addressing a particular subject (or not 

addressing it) might cause others to act (e.g., the SEC or Congress); 

• Convergence Possibilities – the extent to which there is an opportunity to eliminate 

significant differences in standards or practices between the U.S. and other countries with a 

resulting improvement in the quality of U.S. standards; the extent to which it is likely that a 

common solution can be reached; and the extent to which any significant impediments to 

convergence can be identified; 

• Cooperative Opportunities – the extent to which there is international support by one or more 

other standard-setters for undertaking the project jointly or through other cooperative means 

with the FASB; and 

• Resources – the extent to which there are adequate resources and expertise available from the 

FASB, the IASB, or another standard-setter to complete the project; and whether the FASB 

can leverage the resources of another standard-setter in addressing the issue, and thereby add 

the project at a relatively low incremental cost. 

After considering these factors, consulting with other FASB members, and consulting with the 

FASB’s Technical Director (who also chairs the EITF), the Chairman decides whether to add an 

item to the FASB’s agenda. 

 

• Consider, in adopting accounting principles, the extent to which international convergence on high quality 

accounting standards is necessary or appropriate in the public interest and for the protection of investors, 

including consideration of moving towards greater reliance on principles-based accounting standards 

whenever it is reasonable to do so; 

• Take reasonable steps to continue to improve the timeliness with which it completes its projects, while 

satisfying appropriate public notice and comment requirements; and 

• Continue to be objective in its decision-making and to weigh carefully the views of its constituents and the 

expected benefits and perceived costs of each standard. 
162

2. Accessibility of Meetings 

The FASB’s due process incorporates open decision-making meetings and exposure of proposed 

standards for public comment. All technical decisions are made in meetings (generally held at 

the FASB’s offices) that are open to public observation, although public observers do not 

participate in the meeting discussions. A live broadcast of such meetings is available on the 

FASB website. A “Summary of Decisions Reached” is typically available on the FASB’s 

website within a day of public meetings. 

The staff presents written material, including analysis and recommendations, to the FASB 

members in advance as the basis for discussion in a meeting. The written material is the result of 

research by the FASB staff, including a detailed review and analysis of all of the significant 

alternative views for each issue to be discussed at the meeting. The meeting format calls for oral 

presentation of a summary of the written materials by the FASB staff, followed by FASB 

discussion of each issue presented and questioning of the staff. The FASB may reach 

conclusions on one or more of the issues presented. Conclusions reached are tentative and may 

be changed at future FASB meetings. 

3. Public Exposure of Standards 

Each proposed SFAS, Interpretation, or FSP is issued in exposure draft form for public 

comment. When the FASB has reached conclusions on the issues, it directs the staff to prepare a 

proposed exposure draft for its consideration. After further discussion and revisions, FASB 

members vote by written ballot to issue the exposure draft. A majority vote of the FASB is 

required to approve a document for issuance as an exposure draft. Alternative views, if any, are 

explained in the document and posted on the FASB website. 

The exposure draft sets forth the proposed standards of financial accounting and reporting, the 

proposed effective date and method of transition, background information, and an explanation of 

the basis for the FASB’s conclusions. 

At the end of the exposure period, which is determined at the discretion of the FASB and lasts 

typically 60-90 days and generally not less than 30 days (or 15 days in the case of an FSP), all 

comment letters and position papers are analyzed by the FASB staff to identify new information 

and / or persuasive arguments regarding the issue. In addition to studying this analysis, FASB 

members review the comment letters to help them in reaching conclusions.

4. Further Deliberation by the FASB 

After the comments have been analyzed and studied, the FASB typically redeliberates the issues 

in light of input received during the exposure period. As in earlier stages of the process, all 

FASB meetings are open to public observation. The FASB considers comments received on the 

exposure draft or other due process documents and often incorporates suggested changes in the 

final document. If substantial modifications are made, the FASB may decide to issue a revised 

due process document or exposure draft for additional public comment. When the FASB is 

satisfied that the analysis of the issue is complete and reasonable alternatives have been 
163

considered adequately, the FASB staff is directed to draft a final document for consideration by 

the Board. A vote is taken on the final document, again by written ballot. A simple majority is 

required for adoption of a final pronouncement. If the input received by the FASB indicates that 

changes to existing standards are not required, the Chairman may decide to remove the project 

from the FASB’s agenda. 

5. Statements of Financial Accounting Standards 

The final product of most technical projects is a SFAS. The SFAS sets forth the final standards, 

the effective date and method of transition, background information, a brief summary of research 

done on the project, and the basis for the FASB’s conclusions, including the reasons for rejecting 

significant alternative solutions. It also identifies members of the FASB voting for and against 

its issuance and includes reasons for any dissents. 

6. Additional Due Process 

 a. Resource Groups 

For major projects, the FASB generally goes beyond the core due process described above. 

Soon after a major project is placed on the FASB’s technical agenda, a resource group may be 

formed, including preparers, auditors, and users of financial information who are knowledgeable 

about the subject matter. Experts from other disciplines (e.g., tax or valuation experts) also may 

be included. 

The resource group provides information and practical insights from constituents’ perspectives 

on FASB agenda projects. The FASB staff seeks information from resource group members as 

needed throughout the life of a project, for example, as it initially identifies issues to be 

addressed and as it develops its analysis of possible alternative approaches. Resource group 

members also are asked to perform external reviews of drafts of due process documents (see 

below) and final standards. 

During the development of SFAS No. 157, the FASB utilized the support of a resource group of 

investors, preparers, auditors, and valuation specialists. This group had significant experience in 

performing and reviewing valuations for financial reporting purposes. 

 b. Other Due Process 

During development of a standard, usually prior to issuance of an exposure draft, the FASB may 

choose to conduct field visits or field tests for the purpose of assessing the costs and benefits of 

the proposed standard, and also to determine whether it is operational. Further, additional 

discussion papers may be issued for public review and comment. During the comment period of 

a due process document, the FASB also may conduct field tests of its provisions and seek the 

input of ITAC or other advisory groups. 

After a discussion document or an exposure draft is issued for public comment, the FASB often 

holds public roundtable meetings with interested constituents. Those meetings provide an 
164

opportunity for the FASB and staff to solicit further input and ask questions about information 

and viewpoints offered by constituents who participated in the comment process. 

7. Statements of Financial Accounting Concepts 

In addition to SFASs, the FASB also issues SFACs, which do not currently establish new 

standards or require any change in the application of existing accounting principles. Instead, 

they are intended to provide the FASB and constituents with a foundation for setting future 

standards. The framework defined in the SFACs helps the FASB identify the right questions to 

ask in structuring technical projects and contributes to a consistent approach over time. Because 

of their long-range importance, SFACs are developed under the same due process the FASB 

follows in developing SFASs on major topics. The FASB currently has a joint project with the 

IASB to improve the FASB’s conceptual framework. 

8. Other Documents 

In addition to broad issues of financial accounting and reporting, the FASB considers narrower 

issues related to implementation of existing standards and other problems arising in practice. 

Depending on their nature, application and implementation problems may be dealt with by the 

FASB in SFASs, Interpretations, or FSPs. Implementation resource groups are also established 

concurrent with the issuance of certain FASB standards to assist the FASB staff in: (1) keeping 

abreast of issues that are currently being dealt with by preparers and auditors of financial 

statements related to the issuance and adoption of that standard, (2) identifying whether the 

understanding of that standard is being achieved, and (3) evaluating whether there are different 

interpretations of that standard that were not intended. 

As it relates to the issuance and adoption of SFAS No. 157, the FASB created the Valuation 

Resource Group (the “VRG”). The VRG is a collection of 20 valuation specialists, auditors, 

preparers, and investors that provides the FASB staff with information on implementation issues 

surrounding fair value measurements used for financial statement reporting purposes. The VRG 

meetings are closed to the public and minutes are not distributed. The FASB specifically 

designed the VRG to be a means to educate the FASB staff on valuation issues while not 

creating authoritative decisions. 

The VRG was formed in response to the FASB’s Invitation to Comment (“ITC”) on valuation 

guidance for financial statement reporting purposes, issued on January 15, 2007. The purpose of 

the ITC was to solicit information on the need for additional valuation guidance for financial 

reporting, whether the FASB should be responsible for providing such guidance, and what 

process should be used to issue valuation guidance for financial reporting. The ITC posed 

several broad questions aimed at understanding the role that the FASB and existing appraisal 

organizations should play in the development of valuation guidance for financial reporting and 

the process by which guidance should be provided. The FASB received approximately 80 

comment letters on the ITC and held a subsequent roundtable with auditors, valuation specialists, 

trade association representatives, and appraisal organization representatives to discuss the 

participants’ views. 
165

Since October 2007, the VRG has met five times and discussed over 30 issues relating to fair 

value measurements. The results of these discussions led, in part, to the FASB to propose 

additional guidance in the areas of measuring the fair value of liabilities, accounting for 

defensive-use intangible assets, disclosures about post-retirement benefit plan assets, and the 

deferral of the effective date of SFAS No. 157 for certain non-financial assets and liabilities. 

9. Emerging Issues Task Force 

The EITF was formed in 1984 in response to the recommendations of the FASB’s task force on 

timely financial reporting guidance and an FASB Invitation to Comment on those 

recommendations. EITF members include representatives from public accounting firms, 

preparers, and users of financial statements. The Chief Accountant of the SEC, or his or her 

designee, attends EITF meetings as an observer with the privilege of the floor. The EITF meets 

at least four times a year. Meetings are open to the public and, generally, are attended by 

substantial numbers of observers; meetings are also broadcast on the FASB website. 

EITF agenda requests are received in a similar manner as FASB project requests. A 

subcommittee of EITF members, the SEC observer, FASB staff, and the FASB members discuss 

these requests. The FASB Chairman considers input from the agenda subcommittee and decides 

whether to add the request to the EITF’s agenda. 

Composition of the EITF is designed to include persons in a position to be aware of emerging 

issues before they become widespread and before divergent practices regarding them become 

entrenched. The EITF discusses the emerging issue and attempts to reach a consensus. A 

consensus is defined as an agreement, provided that no more than three of the 14 voting 

members object. A draft abstract, after ratification by at least a majority of the FASB members, 

is exposed for public comment as an EITF Consensus for Exposure. Comments are received on 

the Consensus for Exposure and any issues are addressed or reconsidered by the EITF. The final 

Consensus positions of the EITF must be ratified by at least a majority of the FASB members for 

the final consensus to become authoritative U.S. GAAP. If consensus is not possible, it may be 

an indication that action by the FASB is necessary. 

10. Public Record 

Transcripts of public hearings, letters of comment and position papers, research reports, and 

other relevant materials on projects leading to issuance of pronouncements become part of the 

FASB’s public record. The public records on all projects are available for inspection in the 

public reference room at the FASB’s offices in Norwalk, Connecticut. 

D. Recent Activities with Respect to FASB Governance and Process 

In February 2008, the FAF voted to adopt a number of changes proposed by a special committee 

it formed to review FAF oversight of the FASB, as well as elements of the FASB’s internal 

procedures.243 CIFiR’s Final Report also included a number of recommendations on the same 

 

243 See “The Financial Accounting Foundation Board of Trustees Approves Changes to Oversight, Structure and 

Operations of FAF, FASB and GASB,” FAF Release (February 26, 2008). (available at: 
166

general subjects.244 The more salient results of the FAF’s changes and CIFiR’s 

recommendations are summarized below. 

The FAF voted to: 

• Expand the breadth of individuals and organizations invited to submit nominations for the 

Board of Trustees. Seeking additional nominating sources is intended to expand the 

population and diversity of qualified nominees, including those with investor experience, 

who possess the skills and experience that can be useful to the FAF. 

• Change the term of service for Trustees (other than the Chairman) from two three-year terms 

to one five-year term. The intent is to attract a larger number of qualified Trustees, while 

providing all Trustees with additional time to research and become familiar with FAF 

business, while reducing the relative portion of their terms spent doing so. 

• Change the size of the Board of Trustees from 16 members to a range of 14 to 18 members. 

The purpose is to efficiently adjust Trustee resources as FAF workloads fluctuate over time. 

• Reduce the size of the FASB from seven to five, primarily to enhance its ability to respond 

nimbly and quickly to its agenda. 

• Retain the FASB simple majority voting requirement. 

• Affirm the need for investor participation on the FASB by broadening the current by-law 

requirement that FASB members possess investment experience. 

• Provide the FASB Chairman with decision-making authority to set the FASB technical 

agenda after appropriate consultation. This change was made to improve agenda-setting 

efficiency compared to the previous arrangement in which the full FASB voted on agenda 

matters. 

• Strengthen FAF oversight of the FASB standard-setting process, such as by overseeing the 

implementation of a formal process by which the FASB will retrospectively evaluate the 

effectiveness of its standards. 

These changes were adopted and are currently part of FASB’s operations. 

CIFiR indicated that the design of the U.S. standard-setting process, including the process of 

issuing authoritative interpretive implementation guidance and the role played by each 

participant, works well and is generally appropriate.245 Further, CIFiR acknowledged some of its 

 http://www.fasb.org/faf/nr022608.pdf) Further, the FAF requested public comment on the proposals in December 

2007. 

244 See CIFiR Final Report, Chapter 2. 

245 See CIFiR Final Report, at page 56. 
167

recommendations may have been partially or substantially addressed by recent actions of the 

FAF, the FASB, and the SEC. Building on these efforts, CIFiR issued the following 

recommendations: 

• Enhance the investor’s perspective in standard-setting by increasing investor-representation 

on the Board, the FASB staff and FASB’s advisory groups in order to meet the needs of 

those for whom financial reporting standards are primarily designed. 

• Amend the FASB’s mission statement to make the objective of minimizing complexity in 

accounting standards explicit; the FAF should also establish performance metrics to ensure 

key aspects of standard-setting meet the FASB’s stated goals and objectives. 

• Clarify roles with the SEC regarding the issuance of interpretive and / or implementation 

accounting guidance to avoid overlap and potential confusion by constituents. 

• Improve the standard-setting process by: 

o Establishing an FRF that includes key constituents from the preparer, auditor, and 

investor and other user communities, to meet with representatives from the SEC, the 

FASB, and the PCAOB to discuss pressures in the financial reporting system overall, 

both immediate and long-term. 

o Increasing the transparency and consistency of fieldwork during the development of 

accounting standards. Fieldwork generally refers to constituent outreach, for instance 

soliciting preparer and investor input, as well as testing proposed accounting standards on 

the financial statements of volunteers (akin to a pilot program). Fieldwork is used to 

inform the FASB when making its cost-benefit assessments. By increasing the public 

visibility of field work and its consistent application across major projects, financial 

reporting standards should be improved. 

o Conducting post-adoption reviews of major standards to identify unintended 

consequences or other practice issues. The intent is to ensure new standards are 

conveying the intended information at an acceptable cost, within a reasonable range of 

differing interpretations across companies. 

o Periodically assessing existing standards for continued relevance and acceptable costbenefit profiles in light of changing economic conditions. For instance, legacy 

accounting standards for capital-raising activity may not keep pace with marketplace 

developments or accurately convey their substance, such as accounting guidance for 

certain convertible securities and securitization transactions (“off-balance sheet” 

accounting). 

It should be noted that CIFiR’s recommendations reflect its consideration of changes adopted by 

the FAF in February 2008. 
168

E. FASB’s Interaction with the IASB 

The FASB’s objective for participating in international activities is to increase the international 

comparability and the quality of accounting standards used in the United States. This objective 

is consistent with the FASB’s responsibility to its domestic constituents, who benefit from 

comparability of information across national borders. The FASB pursues that objective in 

cooperation with the IASB and national standard-setters. 

As noted in Section I.C, in 2002, the Boards issued the Norwalk Agreement, in which each 

acknowledged their commitment to developing high quality, compatible accounting standards 

that could be used for both domestic and cross-border financial reporting. In that agreement, the 

Boards pledged to use their best efforts to: (1) make their existing financial reporting standards 

fully compatible as soon as is practicable and (2) co-ordinate their future work programs to 

ensure that once achieved, compatibility is maintained. 

In a 2006 Memorandum of Understanding, the Boards indicated that a common set of highquality global standards remains their long-term strategic priority. As part of this commitment, 

the Boards set out a work plan covering several projects and coordinated agendas so that major 

projects that one board takes up may also be taken up by the other board. That plan covered 

specific long- and short-term projects for work into 2008. In November 2007, the Trustees of the 

IASB governing body reiterated their support for continuing the work program described in these 

memoranda, noting that future work is largely focused on areas in which the objective is to 

develop new world-class international standards. Most recently, in September 2008, the Boards 

issued a progress report and a timetable for the completion of joint major projects by 2011 in 

areas such as financial statement presentation, revenue recognition, lease accounting, liabilities 

and equity distinctions, consolidation accounting, and pension and post-retirement benefit 

accounting. 
169

VI. Alternatives to Fair Value Accounting Standards

This section of the study examines the potential impact of a suspension of SFAS No. 157 and 

recent proposals regarding alternative measurement attributes. Specifically, this section 

provides: 

• An analysis of the goals of SFAS No. 157, benchmarked against the state of fair value 

measurements and disclosures prior to the issuance of the standard; 

• Consideration of alternative measurement bases and the concepts and themes underlying 

recent proposals; and 

• A description of issues related to auditing practices that may warrant further consideration in 

determining whether additional guidance for auditors would be helpful. 

This section of the study is based on publicly available information from the Boards and a review of 

applicable academic literature. 

Overall, suspending SFAS No. 157 would not eliminate fair value accounting. Instead, it would 

return practice to a state in which fair value accounting exists, but without a consistent 

framework for determining those measurements. As to alternatives to fair value accounting, 

while such alternative measurement bases exist, each alternative exhibits strengths and 

weaknesses, as well as implementation issues. Considering evidence regarding the usefulness of 

fair value information to investors, the suspension of fair value accounting to return to historical 

cost-based measures would likely increase investor uncertainty and adversely impact equity 

values by removing access to information at a time when that information is likely most useful to 

investors. However, given the significant challenges faced in implementing existing standards, 

additional actions to improve the application and understanding of fair value requirements are 

advisable. 

A. Impact of a Suspension of SFAS No. 157 

As noted in Section I.D of this study, SFAS No. 157 defines fair value, establishes a framework 

for measuring fair value in U.S. GAAP, and requires expanded disclosures about fair value 

measurements. SFAS No. 157 does not require any fair value accounting. Rather, SFAS No. 

157 is applied when other specific GAAP pronouncements either require or permit fair value 

measurements.246 As such, suspending SFAS No. 157 will not, in and of itself, remove any 

requirements to apply fair value (or mark-to-market) accounting. Instead, the suspension or 

elimination of SFAS No. 157 would merely remove the application guidance on the 

measurement of fair value. Further, suspension of SFAS No. 157 would eliminate the 

requirement for expanded disclosures regarding fair values (including disclosures related to the 

fair value hierarchy). 

 

246 See SFAS No. 157, paragraphs 1 and 2. 
170

SFAS No. 157 was developed in response to the perceived need for increased consistency and 

comparability in fair value measurements (and for expanded disclosures about fair value 

measurements).247 That is, there was a perceived need for a common set of instructions for 

application in situations where U.S. GAAP (in this case, pre-existing U.S. GAAP) calls for or 

permits the use of fair value. Prior to the guidance and expanded disclosures provided in SFAS 

No. 157, different definitions of fair value existed in U.S. GAAP, having evolved in a piecemeal 

fashion over time. Limited guidance for applying those different definitions existed, and the 

guidance that did exist was dispersed among the many accounting pronouncements that referred 

to fair value.248 

Differences in the definitions of and guidance about fair value were believed to create 

inconsistencies in the application of fair value measurement, which contributed to additional 

complexity in applying U.S. GAAP. Elimination of the potentially inconsistent application is 

consistent with the advice of CIFiR, which cited incomparability and inconsistency in the 

reporting of activities as one of the significant causes of complexity.249 With respect to fair 

value, and as noted in Section IV.C of this study, the final CIFiR report notes that “optimally, the 

FASB should develop a consistent approach to determine which measurement attribute should 

apply to different types of business activities (in particular, it should address whether and when 

fair value should be used).”250 As previously discussed, the final CIFiR report recommended that 

the FASB be judicious in requiring fair value measurement in additional circumstances until 

additional steps are taken.251 CIFiR also supported additional disclosure and presentation 

requirements. 

Several of the concepts within SFAS No. 157 were present to varying degrees in many of the 

amended standards. However, the standard clarified at least three main aspects of the fair value 

definition and provided additional disclosure and implementation guidance. For example, while 

much of the pre-SFAS No. 157 literature was consistent regarding the concept of fair value as a 

current sale price between a willing buyer and a willing seller, it was not clear in application 

whether exit prices or entry prices were used. SFAS No. 157 provided for a consistent approach 

by: 

• Explicitly defining fair value as an exit price concept; 

• Clarifying the use of market participants’ perspectives (rather than entity-specific 

information) and the principal (or most advantageous) market to further define the market 

price; and 

 

247 See SFAS No. 157, Summary and paragraph C4. 

248 See SFAS No. 157 (as amended by FSP FAS 157-1, Application of FASB Statement No. 157 to FASB Statement 

No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease 

Classification or Measurement under Statement 13), Appendix D, which lists 59 previously issued APB and FASB 

pronouncements that refer to fair value, of which 27 were amended by SFAS No. 157, as outlined in SFAS No. 157, 

Appendix E. 

249 See CIFiR Final Report, at page 19. 

250 CIFiR Final Report, at page 27. 

251 See CIFiR Final Report, at pages 27-28. 
171

• Introducing a fair value hierarchy that differentiated between Level 2 and Level 3 inputs. 

While prior standards indicated a clear preference for observable market prices for identical 

assets or liabilities over both the prices of other similar assets or liabilities and model-based 

estimates, prior standards did not provide clear, uniform guidance on the relationship between 

prices of similar items and model estimates or that the valuation techniques used to measure fair 

value should maximize the use of observable inputs and minimize the use of unobservable 

inputs.252 Also absent from the prior standards were the uniform disclosure requirements 

(particularly for Level 3 estimates), the implementation guidance provided in Appendix A of 

SFAS No. 157 (which provides numerous examples of measurement applications and 

disclosures), and Appendix B of SFAS No. 157 (which provides additional clarification on the 

application of the present value techniques discussed in SFAC No. 7). 

However, there have been criticisms and concerns about how successful SFAS No. 157 was in 

applying a consistent measurement framework.253 For example, although SFAS No. 157 defines 

fair value in terms of exit values, some have suggested that several examples in the application 

guidance instead employ entry values or value-in-use. Further, although SFAS No. 157 excludes 

transaction costs from fair value estimates, some have suggested that examples often include 

transaction costs. To the extent that such inconsistencies exist, some level of incomparability in 

fair value estimation could remain. 

Such concerns, however, do not necessarily suggest that SFAS No. 157 should be suspended. A 

suspension of SFAS No. 157 would effectively remove the measurement and disclosure 

guidance (the common instruction manual) without removing the requirement (or, under some 

circumstances, the option) to apply fair value measurement embedded in numerous other 

standards. Such a suspension would be akin to a move from an objectives-based standard to a 

principles-only standard. That is, as other pre-existing standards require (or in some cases 

permit) the use of fair value, the elimination of SFAS No. 157 would not reduce fair value 

accounting requirements. Rather, it would result in less guidance related to how to comply with 

existing standards. The Staff has previously noted that a principles-only approach would often 

lack the guidance needed to reliably operationalize a principle, with a significant loss of 

comparability among reporting entities as a potential result.254 Instead, such concerns suggest 

that it is advisable to review the application of SFAS No. 157, including guidance provided in 

Appendix A of SFAS No. 157, to ensure that the application of the standard is consistent with 

the concepts of fair value in the standard. Further, as noted in Section VII.A, the need for 

additional implementation guidance has been recognized by both Boards, particularly in the area 

of determining fair value in inactive markets. Both Boards also have already begun to provide 

such guidance. 

 

252 See SFAS No. 157, paragraph 21. 

253 See, e.g., George J. Benston, The Shortcomings of Fair-Value Accounting Described in SFAS 157, 27 Journal of 

Accounting and Public Policy 2 (2008), 101–114. 

254 See, e.g., Principles-Based Accounting Study, Section I.C. 
172

In contrast, rather than suspending the disclosure guidance, some have suggested that additional 

disclosure would be appropriate, such as the assumptions used to arrive at Level 3 estimates and 

the sensitivities of Level 3 valuations to variations in these assumptions.255 Similarly, as noted in 

Section VII.A, the Division of Corporation Finance in March and September 2008 issued “Dear 

CFO” letters. These letters cover common themes in comment letters from the Division of 

Corporation Finance to registrants and identify current disclosure issues, including calling for 

additional disclosures regarding Level 3 estimates such as a discussion of how sensitive the fair 

value estimates for material assets or liabilities are to the significant inputs used in the valuation 

technique or model.256 Although companies did respond by enhancing some disclosures, the call 

for additional voluntary disclosure of sensitivity analyses has generally not been answered.257 

The voluntary nature of the additional disclosures may have contributed to the lack of response. 

In particular, the desire to avoid the costs of potential litigation arising from inaccurate 

disclosure may reduce managers’ incentive to provide such additional disclosures on a voluntary 

basis, even where such additional disclosures would produce net benefits to the capital markets. 

B. Recent Proposals Regarding Measurement Attributes 

From the various recent public dialogues over fair value accounting, one area of concern appears 

to be a possible lack of understanding surrounding the concept of “fair value” and its application 

in the accounting literature. For example, in addition to a misconception among some that SFAS 

No. 157 itself requires fair value accounting, other misconceptions are that the requirements in 

SFAS No. 157 apply only to instances where a market price cannot be determined, or that SFAS 

No. 157 requires preparers to use observable prices in inactive or disorderly markets, neither of 

which is accurate. SFAS No. 157 assigns the highest priority within the fair value hierarchy to 

quoted prices in active markets for identical assets or liabilities (i.e., Level 1), with multiple 

permissible valuation techniques (consistent with a market approach, income approach, or cost 

approach).258 Further, as discussed in Section VII.A, recent clarifications from the SEC’s Office 

of the Chief Accountant and the FASB, as well as guidance from the FASB and the IASB, have 

helped to provide additional clarity on the measurement of the fair value of a financial asset in 

inactive markets. 

Nevertheless, specific suggestions for alternate measurement methods have received recent 

attention in popular debate, including returning to a cost-based measurement method for 

particular financial instruments, using a “rolling average” of fair values, and using “fundamental 

value” methods.259 It appears likely that many of the recent calls from credible and experienced 

 

255 See Stephen G. Ryan, Fair Value Accounting: Understanding the Issues Raised by the Credit Crunch (White 

Paper) Council of Institutional Investors (2008). 

256 For the March 2008 letter, see http://www.sec.gov/divisions/corpfin/guidance/fairvalueltr0308.htm; for the 

September 2008 letter, see http://www.sec.gov/divisions/corpfin/guidance/fairvalueltr0908.htm. 

257 See, e.g., Stephanie Hunsaker, Associate Chief Accountant, Division of Corporation Finance, SEC, Remarks 

Before the 2008 AICPA National Conference on Current SEC and PCAOB Developments, (December 9, 2008). 

258 See SFAS No. 157, paragraph 18. 

259 On cost-based variations, see letters from, e.g., Fischer, Cross (October 6 and October 17, 2008), Gorton, Isaac, 

and Vetter. On rolling average, see, e.g., Newt Gingrich, Commentary: Suspend Mark-to-Market Now!, September 

29, 2008, Forbes.com, (available at http://www.forbes.com/opinions/2008/09/29/mark-to-market-opedcx_ng_0929gingrich.html) and Thomas Seeberg, Michael Starkie & Carsten Zielke, Fair Value Move Could Break 
173

parties to suspend SFAS No. 157 were not simply a call for a suspension of the application 

guidance provided in that standard, but rather, could or should be viewed as calls to reconsider 

pre-existing fair value requirements for financial instruments. Thus, this section provides a 

consideration of alternative treatments to existing standards. Specifically, this section of the 

study examines a number of alternative models regarding how to measure investments, 

discussing the broader issues related to identifying appropriate measurement bases. 

1. Broader Issues Related to Identifying Appropriate Measurement 

Bases 

As noted in Section I.D of this study, the Boards have been engaged in ongoing work to improve 

their existing conceptual frameworks, with Phase C of their project focused on measurement. 

Exhibit VI.1 below depicts the nine measurement basis candidates identified by the Boards’ 

staffs in their work on the project. 

Exhibit VI.1: FASB / IASB Measurement Basis Candidates by Time Frame (with Variations*) 

Basis: Time Frame: 

 Past Present Future

Entry Past entry price 

(e.g., without or with 

related prices**) 

Current entry price 

(e.g., without or with 

related prices,** 

including identical 

replacement, identical 

reproduction, equivalent 

replacement, productive 

capacity replacement) 

Future entry price 

(e.g., without or with 

related prices**) 

Exit Past exit price 

(e.g., without or with 

related prices**) 

Current exit price 

(e.g., without or with 

related prices**) 

Future exit price 

(e.g., without or with 

related prices**) 

Other 

In practice Modified past amount 

(e.g., accumulated, 

allocated, amortized, 

combined) 

Value in use

Alternative Current equilibrium 

price 

*The Boards have agreed to focus on the primary measurement bases rather than on the variations during the 

remainder of the measurement phase. 

 the Writedown Spiral, Financial Times, April 3, 2008, at page 27. On fundamental value, see, e.g., the September 

30, 2008 letter from multiple members of Congress (available at: 

http://www.complianceweek.com/s/documents/SEConFV.pdf), comments of Isaac at October 29, 2008 SEC 

Roundtable; and letters from ABA (September 23, 2008), ACCU, Sigmon, Southwest, and WesCorp. 
174

**Related prices refer to acquisition- or incurrence-related goods or services (e.g., sales tax or VAT, delivery or 

shipping charges, brokerage fees, and underwriting costs).

The Staff notes that the terms “historical cost” and “fair value” are noticeably absent from the list 

of measurement bases. The stated reason by the Boards for their absence is that there is little 

common understanding of these terms. The same general term can refer to a number of different 

bases (as well as to a number of potential application decisions within a measurement basis), 

with the speaker or the listener being potentially unaware of the need to distinguish among the 

different meanings. Accordingly, the use of the terms can lead to miscommunication and 

misunderstanding.260 In the list of measurement basis candidates, the general concept of 

“historical cost” is represented by measurements relating to the past (past entry price, past exit 

price, and modified past amount). Similarly, the general concept of “fair value” is represented 

by measurements relating to the present (current entry price, current exit price, current 

equilibrium price, and value in use). The list also includes measurement bases relating to the 

future (future entry price, future exit price). However, because such future values generally have 

not been suggested as part of the current debates over fair value, the Staff omits them from 

further discussion in this study. 

Fair value as implemented in SFAS No. 157 is best described as a current exit price at the 

measurement date. The FASB concluded that an exit price objective is appropriate because it 

embodies current expectations about the future inflows associated with the asset and the future 

outflows associated with the liability from the perspective of market participants.261 The IASB’s 

Discussion Paper on Fair Value Measurements identifies the explicit definition of fair value as an 

exit (selling) price as one of the key differences between SFAS No. 157 and fair value under 

IFRS, which does not explicitly define fair value as either an exit price or an entry (buying) 

price.262 Many respondents to the Fair Value Measurements Discussion Paper considered “fair 

value” to be a family of measurement bases, and as such recommended replacing the term “fair 

value” with more descriptive terms such as “current exit price” and “current entry price.”263 

 

260 See Milestone I Summary Report. Some have also objected to the emotive use of the term “fair” value. See, e.g., 

comments of Isaac at October 29, 2008 SEC Roundtable. 

261 The Basis for Conclusions in SFAS No. 157 notes (in paragraph C26) that the emphasis on inflows and outflows 

is consistent with the definitions of assets and liabilities in SFAC No. 6, but does not include any further discussion 

of the alternative bases explored. One criticism of fair value as implemented in SFAS No. 157 is that the application 

of a current exit value may be inappropriate when a company expects to continue its operations as an ongoing entity. 

This criticism is discussed further in Section VI.B.2.a. 

262 See Fair Value Discussion Paper, paragraph 10. Paragraph 5 of SFAS No. 157 defines fair value as “the price 

that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market 

participants at the measurement date.” As generally defined in IFRS, fair value is “the amount for which an asset 

could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction.” 

However, slight variations exist across different IFRS in the precise wording used to describe fair value. 

263 In the comment letters received by the IASB on the Fair Value Discussion Paper, many respondents also believed 

that the objectives of financial reporting need to be determined before commenting on whether an exit or an entry 

price is most appropriate. (IASB staff, Information for Observers, Board Meeting, October 17, 2007, Fair Value 

Measurement, Staff Analysis of Comment Letters (Agenda Paper 2C). See paragraphs 9, 14, and 19.) Nearly half 

of the respondents believe the fair value measurement project should not be completed before the completion of the 

conceptual framework project. 
175

The Staff therefore applies two approaches in its analysis of measurement bases. First, the Staff 

focuses on the time orientation (i.e., comparing the concepts of past versus current values). 

Second, the Staff discusses measurement methods within time orientations. 

a. Past versus Current Values 

Putting aside application issues associated with measurement, a pure historical cost accounting 

model would report a balance sheet with entirely past values, whereas a pure fair value 

accounting model would report a balance sheet with entirely current values.264 In contrast, U.S. 

GAAP and IFRS currently employ a mixed-attribute model, in which some items are measured 

at historical cost (or cost-based variations) and some items are measured at current values.265 

Both pure models could serve to communicate information regarding company value to 

shareholders, albeit in somewhat different ways. Both pure models also face implementation 

issues. 

Under a pure fair value accounting model, the balance sheet would become the primary vehicle 

for conveying information about company current value to shareholders. This approach would 

appear consistent with the stated objectives of financial reporting discussed in SFAC No. 1, 

which is to “provide information about the economic resources of an enterprise, the claims to 

those resources (obligations of the enterprise to transfer resources to other entities and owners’ 

equity), and the effects of transactions, events, and circumstances that change resources and 

claims to those resources.”266 Income would, under a pure fair value approach, represent 

“economic income,” capturing the changes in the current balance sheet values. Implementation 

challenges under a pure fair value accounting model center around obtaining appropriate current 

values for the balance sheet items, including multiple valuation and judgment issues, particularly 

for long-lived assets where a market may not exist or a sale was not expected, such as property, 

plant, or equipment. 

Under a pure historical cost accounting model, the income statement would be a more primary 

vehicle for conveying information about “realized” income to shareholders. Income would not 

represent shareholders’ “economic income,” but rather the value added by buying inputs from 

suppliers, transforming them according to the company’s business model, and selling the 

resulting outputs to customers. Income would not represent “the (present) value of expected 

outcomes from the business plan [but rather], it [would] report on progress that has been made in 

executing the plan.”267 The balance sheet would not necessarily be a statement of values, but 

 

264 See Stephen H. Penman, 37 Accounting and Business Research (Special Issue: International Accounting Policy 

Forum) (2007), at 33-44. 

265 Many policy analyses of fair value seem to assume a “full fair value” approach. See, e.g., Treasury 1991 Bank 

Report; European Central Bank 2004. However, see International Monetary Fund, Global Financial Stability Report 

(October 2008) (“IMF GFSR”) (available at: http://www.imf.org/external/pubs/ft/gfsr/2008/02/index.htm) for a 

possible exception. As described in Section I.B and as documented in Section II.B, this is not the current system 

under U.S. GAAP. 

266 SFAC No. 1, paragraph 40. 

267 Stephen H. Penman, 37 Accounting and Business Research (Special Issue: International Accounting Policy 

Forum) (2007), at 36-37.
176

rather a by-product of a matching process between revenues (realized income) with expenses. 

Implementation challenges for valuation under a pure historical cost accounting system center 

around appropriate matching, forecasting, and estimation of a required rate of return (to discount 

future income). Within the accounting standards, multiple judgment issues would also exist 

(e.g., revenue recognition, accruals and deferrals, and allocations). With respect to financial 

institutions, for example, a critical estimate would be for their loan loss reserves. 

As noted, both models would serve to communicate information regarding a company to 

shareholders, albeit in different ways. A pure fair value approach may be viewed by some as 

focused on the balance sheet, whereas a pure historical cost approach is focused on matching 

historical costs with realized income in the income statement. This basic difference in approach 

contributes to an often-cited concern about fair value: that there is an inconsistency between the 

fair value accounting model and a typical company’s business model as an ongoing entity.268 

There is also a perceived conflict between the company as a going concern and the need to 

capture current values for assets and liabilities using an exit price in particular. 

The difference in approach likely contributes to the persistence of the mixed-attribute model in 

both U.S. GAAP and IFRS. The use of mixed-attribute accounting can be viewed as consistent 

with the belief that “fair value is not appropriate when there is a top-line notion of a customer 

from whom value is received in an exit price, with value added over an input price” but “is 

appropriate when value comes from property rights and obligations, and value is added or lost 

(solely) from fluctuations in the market values of those rights and obligations.”269 This is, for 

example, one rationale for mark-to-market accounting requirements for derivatives and trading 

assets of financial institutions. Additional concerns also may exist to the extent that current 

values of individual assets and liabilities do not capture the synergies involved when those assets 

and liabilities are used in combination in the company’s ongoing operations.270 

This difference in approach is a fundamental issue faced in accounting standard-setting. 

Accounting standard-setters appear to have determined their conceptual preference, with the 

FASB’s SFAC No. 6 and the IASB’s Framework for the Preparation and Presentation of 

 

268 See, generally, discussion at October 29, 2008 SEC Roundtable. See also, e.g., letters from ACLI, Central 

(October 27, 2008), Cox, Roundtable, MBA, Smith, and Varley. Some might interpret this as a need to clarify the 

role of stewardship as an objective of financial reporting. (See, e.g., paragraph 32 in Summary Report of the 

Conceptual Framework Measurement Roundtables, Hong Kong, London, and Norwalk, January and February 

2007). However, others might argue that both the pure fair value and the pure historical cost approaches can assist in 

the evaluation of management’s stewardship role, with the economic income provided by a pure fair value approach 

reporting the total value added for shareholders. See Stephen H. Penman, 37 Accounting and Business Research 

(Special Issue: International Accounting Policy Forum) (2007), at 33-44. 

269 Stephen H. Penman, 37 Accounting and Business Research (Special Issue: International Accounting Policy 

Forum) (2007), at 39. Penman also notes in footnote 11 that “[t]he perspective is similar to that under Coase’s 

transactions cost theory of the firm. Firms exist because markets are not perfect and thus prices do not measure 

value under all conditions. Firms and their hierarchies are more efficient than markets in some respect, 

entrepreneurs exploit those efficiencies, and historical cost accounting reports the efficiency of firms in dealing with 

imperfect prices.” 

270 Such concerns would also exist with the measurement of assets and liabilities at historical cost, but may be 

alleviated to some extent because the balance sheet under a pure historical cost system does not purport to capture 

the underlying value of the entity. 
177

Financial Statements both implying that the balance sheet is primary. Both conceptual 

statements define assets and liabilities with respect to economic resources, whereas revenues and 

expenses tend to be defined with respect to changes in assets and liabilities. The continued use 

of current (fair) values is consistent with this conceptual preference,271 but to the extent that 

interested parties (e.g., users, preparers, or auditors) disagree,272 there will likely continue to be 

ongoing dissent as to the continued use of current values in financial reporting. 

b. Measurement Methods Within Past or Current Values 

“Fair value” as implemented in SFAS No. 157 is best described as a current exit price at the 

measurement date. As it relates to accounting for investments of financial instruments, 

alternative current values could be implemented, including a current entry price (e.g., 

replacement value), a current equilibrium price (e.g., in a hypothetical arm’s-length transaction 

conducted in an efficient, complete, and perfect market), and a current value-in-use (e.g., based 

on discounted expected future cash flows, sometimes referred to as ‘fundamental value’ or 

‘intrinsic value’). 

Some have noted a potential conflict between measuring value through current exit prices (as in 

SFAS No. 157) and the expectation that the reporting entity will continue its operations as a 

going concern. However, the alternative current values are not independent of one another. For 

example, the current exit price of an asset is the price that an entity would receive currently in 

exchange for selling its asset, but that transaction has a counterparty (albeit hypothetical) that is 

paying an amount in exchange for purchasing the asset (i.e., current entry price).273 

Similarly, in considering the values bid or asked when buying or selling an asset, rational 

decision-makers should theoretically each be estimating the discounted expected future cash 

flows associated with the asset in question. Although differences in values may exist due to the 

competitive advantages of one party over another in using the related economic resources (and 

 

271 For example, in SFAS No. 157, the FASB concluded that a current exit price objective for measuring fair value is 

appropriate because it embodies current expectations about the future inflows associated with the asset and the 

future outflows associated with the liability from the perspective of market participants (see prior footnotes). The 

IASB continues to support the use of fair value (in some variation) because “fair value seems to be the only measure 

that is appropriate for all types of financial instruments.” IASB Discussion Paper, Reducing Complexity in 

Reporting Financial Instruments (March 19, 2008). 

272 For example, user-respondents appear to support the use of fair value for all financial instruments, whereas 

preparer and auditors tended not to support the use of fair value for all financial instruments, in part because of 

concerns about the appropriateness of fair value when the financial instruments were not held for trading purposes or 

managed on a fair-value basis. See Boards’ joint meeting, Education Session Handout for papers 8 and 8A: 

Accounting for Hedging Activities & Reducing Complexity in Reporting Financial Instruments, paragraph 8-9 

(October 21, 2008). (available at: http://www.iasb.org/NR/rdonlyres/89672D67-1C26-4C8C-AEC1-

88E33F2059AB/0/FI0810jointb08handoutobs.pdf) 

273 Differences may exist in the related transaction costs for entry versus exit, and differences may also exist if the 

asset is reproduced (rather than purchased), if the asset is equivalent (but not identical), or if the productive capacity 

of the asset is replaced (rather than the asset itself). Nevertheless, the underlying economic values remain related to 

one another. Others have also noted that while entry prices and exit prices may differ, the transaction price will 

often equal the exit price and, therefore, represent the fair value of the asset or liability at its initial recognition. See 

SFAS No. 157, paragraphs 16 and 17. 
178

due to genuine differences of opinion), at least in theory, the current exit, entry, equilibrium, and

value-in-use estimates should remain associated with one another,274 and each would therefore 

likely face similar implementation concerns. For example, implementation of an equilibrium 

price concept would require companies and auditors to determine the price of an asset in a 

hypothetically “perfect” market, thus introducing the need for management to determine the 

extent to which current markets result in inefficient prices. 

In contrast, “historical cost” is often thought of as a past entry price, the price that an entity paid 

in exchange for purchasing an asset or was paid in exchange for incurring a liability as part of a 

past transaction. However, historical cost also faces measurement difficulties and uncertainties. 

Necessary judgments, include, for example, whether the recorded balance sheet values should 

capture prices paid for acquisition-related goods or services (e.g., sales tax, delivery and 

installation charges, broker commissions, underwriting costs, late fees), what should happen if 

the transactions occur over multiple periods of time, how to allocate a single transaction price to 

multiple individual assets and liabilities, how to assign some of the price to subsequent 

accounting periods (according to an accounting rule for amortization or depreciation), and what 

to do in circumstances when either a temporary or other-than-temporary change (e.g., an 

impairment) in value may have occurred.275 In practice, historical cost is not a pure past entry 

price, but variations on past entry prices adjusted by the application rules, conventions, and 

judgments for a number of potential events. Further, in practice, historical cost standards have, 

for decades, included various requirements to write down an asset where current value exceeds 

the historical cost measure. Thus, historic cost measures tend to result in a requirement to 

account for assets on a lower-of-cost-or-fair-value basis. 

2. Concepts and Themes Underlying Recent Proposals 

The prior subsection summarized the possible measurement bases identified in the measurement 

phase of the Boards’ joint conceptual framework project, comparing and contrasting these 

measurements bases with “fair value” as defined in SFAS No. 157. This subsection addresses 

the concepts and themes underlying specific recent suggestions of alternatives to fair value as a 

measurement basis. 

 

274 Under ideal market conditions, the entry price, exit price, and value-in-use of financial instruments should be 

identical. Specifically, the entry and exit prices should be identical if a financial instrument trades in perfect or 

frictionless markets (i.e., where there are zero transaction costs and deep liquidity). To the extent that ideal market 

conditions do not prevail and market frictions exist (e.g., with only a very small number of market participants who 

may behave strategically), entry and exit prices can diverge. See Guillaume Plantin, Haresh Sapra & Hyun Shin, 

Marking-to-Market: Panacea or Pandora’s Box?, 46 Journal of Accounting Research 2 (2008), at 435-460. 

Similarly, if the value to shareholders of a financial instrument is derived solely from the instrument itself, the 

value-in-use of the financial instrument should again be identical to the exit and entry price under ideal market 

conditions. However, to the extent that the value to shareholders from holding a financial instrument is derived 

from some other source (e.g., from hedging an underlying economic exposure or from an embedded intangible asset 

like “core deposit intangibles”), then value-in-use may deviate from exit and entry prices. See Stephen H. Penman, 

37 Accounting and Business Research (Special Issue: International Accounting Policy Forum) (2007), at 33-44. See 

also, e.g., Treasury 1991 Bank Report at XI-18 and FASB Meeting Handout, Conceptual Framework, November 5, 

2008, paragraph 5 (and paragraph 10 for discussion of when such optimal conditions might exist). 

275 See additional discussion of OTTI in Section VII.A. 
179

As noted above, recent suggestions have included recommendations to measure particular 

financial instruments at cost (or to use cost as a basis in the absence of quoted prices or where 

markets are illiquid), using a “rolling average” of fair values (rather than “current” fair values), 

or using “fundamental value” methods. Such suggestions vary around two main themes: (1) 

eliminate fair value measurement for some or all assets and liabilities, and (2) modify (or, in 

some proposals, eliminate) what is considered to be a current value measure to adjust for certain 

market conditions. Both themes relate to the broader question of an appropriate measurement 

basis. 

a. Theme 1 – Modify Fair Value (For Example, Return to 

Historical Cost) 

Challenges to fair value accounting have generally centered on four main concerns,276 as 

discussed below. 

First, that fair value accounting is potentially unreliable in the absence of quoted market 

prices, resulting in a reduction of comparability and reliability of financial statements.277 

As discussed in Section IV, input received during the course of this study and the results of a 

large number of academic studies support the view that fair value information is useful to 

investors. However, some of these studies also provide evidence consistent with fair value 

estimates based on actively-traded markets being more reliably associated with share prices than 

fair value estimates based on illiquid markets or internal model estimates. More recently, 

academic research has examined the incremental value relevance of the fair value hierarchy 

levels under SFAS No. 157 using data from the first quarter to the third quarter of 2007,278 with 

results suggesting that disclosures under Level 1 and 2 of the fair value hierarchy (i.e., reflecting 

quoted prices in active markets for the identical asset or liability, and other observable inputs for 

the asset or liability, respectively) are value relevant to equity investors, while disclosures under 

Level 3 of the fair value hierarchy (i.e., reflecting unobservable inputs) are less value relevant.279 

 

276 An additional potential concern has been suggested regarding whether the imposition of particular accounting 

requirements can affect economic decision-making (e.g., whether the imposition of fair value accounting may cause 

unforeseen negative consequences on economic decision-making, such as whether to enter into a business 

combination). See, e.g., comments of Maimbourg with respect to SFAS No. FAS 141R at the October 29, 2008 

SEC Roundtable and letter from ABA (November 13, 2008). However, it has also been suggested that valuations of 

acquired assets (such as core deposit intangibles for depository institutions) are routinely undertaken when 

performing due diligence for prospective mergers and acquisitions. See, e.g., Treasury 1991 Bank Report at XI-17. 

277 See, e.g., letters from ABA (September 23, 2008), ACCU, Roundtable, Tchingambu, Southwest, and WesCorp. 

278 See Song, et al. 

279 Data limitations can affect the ability to generalize from this research in several ways. For example, because 

SFAS No. 157 is effective for fiscal years beginning after November 15, 2007 (i.e., 2008 for firms with a calendar 

year end), the data from the first to third quarters of 2007 that is examined by Song, et al. is necessarily limited to 

the small sample (n=167) of companies that chose to adopt the standard early and therefore may not provide 

representative results for companies in general. As of December 1, 2008, the Staff has been unable to find any 

publicly available research based on data drawn from the current global economic crisis with the exception of Song, 

et al. However, as a draft manuscript, Song, et al. will be subject to revision as the manuscript proceeds through the 

publication peer-review process. While the current results of Song, et al. suggest that fair value information 

continued to be value relevant to investors during the current crisis, this issue could benefit from further study. As 
180

Overall, while concerns exist regarding the reliability of fair value estimates under some 

conditions, research suggests investors view fair value information as relevant.280 Concerns over 

the estimates’ reliability generally do not appear to have prevented fair value estimates from 

being useful to investors, although supplemental disclosures may provide additional helpful 

information, especially in the case of Level 3 fair value estimates, as previously discussed. 

Whether investors view such supplemental fair value disclosures as being incrementally useful 

may still depend on investors’ level of comfort with respect to the reliability of the inputs to 

Level 3 fair value estimates.281 

Concerns regarding comparability are often raised in the context of fair value accounting in the 

absence of quoted prices. However, others point out that historic cost accounting results in the 

potential for an even greater lack of comparability, as assets are valued based upon differing 

purchase prices, resulting in identical individual assets with different assigned values. 

Second, that fair value accounting will increase volatility in reported income.282

A number of academic studies have examined this issue as it relates to the impact of fair value 

accounting on banks. For example, using information on fair value disclosures, one study 

estimated banks’ income and regulatory capital using a computed proxy for full fair value 

accounting for investment securities, and found that the volatility of both banks’ income and 

regulatory capital is higher under fair value accounting.283 Another recent study examined the 

difference in the volatility of reported U.S. GAAP net income, reported U.S. GAAP 

comprehensive income, and a computed proxy for full fair value income for a sample of 

commercial banks.284 The full fair value proxy estimates what income would have been had fair 

value been applied even to financial instruments that are not otherwise measured at fair value in 

the published financial statements (e.g., items such as HTM investments are adjusted to be at fair 

value), with all unrealized fair value gains and losses taken into income. This study found that 

income volatility under the full fair value proxy is more than three times higher than the reported 

 of December 1, 2008, the Staff has also been unable to find any publicly available research examining the potential 

change in the relative usefulness of Levels 1, 2, and 3 disclosures to investors during the global economic crisis. 

280 See Section IV.E for a discussion of available academic studies addressing the impact of fair value accounting on 

the quality of information available to the investor; Stephen G. Ryan, Fair Value Accounting: Understanding the 

Issues Raised by the Credit Crunch (White Paper) Council of Institutional Investors; Stephen G. Ryan, Accounting 

in and for the Subprime Crisis, The Accounting Review, (Forthcoming) (2008); and Section IV.B discussion of SEC 

Roundtables. 

281 Because of potential concerns over management biases, for example, Karl A. Muller, III. & Edward J. Riedl, 

External Monitoring of Property Appraisal Estimates and Information Asymmetry, 40 Journal of Accounting 

Research 3 (2002), at 865–881, find evidence for U.K. property firms consistent with investors viewing asset 

revaluation estimates based on external appraisals as more reliable than managerial estimates. 

282 See, e.g., Mary E. Barth, Wayne R. Landsman & James M. Wahlen, Fair Value Accounting: Effects on Banks’ 

Earnings Volatility, Regulatory Capital, and Value of Contractual Cash Flows, 19 Journal of Banking and Finance 

3−4 (1995), at 577-605. 

283 See Ibid. 

284 See Leslie D. Hodder, Patrick E. Hopkins & James M. Wahlen, Risk-relevance of Fair-Value Income Measures 

for Commercial Banks, 81 The Accounting Review 2 (2007), at 337-375. 
181

volatility of then-current U.S. GAAP comprehensive income, and more than five times higher 

than the reported volatility of then-current U.S. GAAP net income. However, this study also 

found that the incremental volatility of income under the full fair value proxy (i.e., beyond 

volatility in net income and comprehensive income) is associated with various measures of 

market risk (namely, the volatility of stock returns, the sensitivity of stock returns to changes in 

the overall market, and the sensitivity of stock returns to changes in long-term interest rates), 

suggesting that the increased income volatility under the full fair value proxy reflects underlying 

economic risks. 

Third, that there is an inconsistency between measuring assets and liabilities at current values 

(especially at a current exit value) when it is expected that a company will continue its 

operations as an ongoing entity.285

For banks and insurance companies in particular, there is a concern regarding whether there is an 

inconsistency between the application of the fair value accounting model and their business 

model for particular assets and liabilities – for example, whether fair values bear sufficient 

relationship to contracted future cash flows when the investments are intended to be HTM, and 

whether fair value principles reflect properly the way in which banks manage their core 

business.286 Some have noted that, despite management’s intent, it remains management’s 

responsibility to assess the most productive uses of the company’s resources on a continuing 

basis, with the current market price representing the actual opportunity to convert an investment 

into cash to be used for other purposes.287 As previously discussed in Section VI.B.1.a, however, 

the relative emphasis on the balance sheet versus the income statement (and the resulting basic 

difference in approach) appears to be a fundamental question to be resolved in accounting 

standard-setting (leading to the mixed-attribute models inherent in both U.S. GAAP and IFRS). 

Disagreements surrounding the continued use of current values in financial reporting may be 

alleviated if accounting standard-setters are able to explicitly address the issues around the 

relative emphasis on the balance sheet versus the income statement. Such concerns are also 

consistent with CIFiR’s suggestion of judiciousness in requiring fair value measurement in 

additional circumstances until the FASB completes its measurement framework, as previously 

discussed. 

 

285 See, e.g., letters from ACLI (October 30, 2008), Central (October 27, 2008), Cox, Roundtable, MBA, Smith, and 

Varley. 

286 For example, the American Bankers Association notes on its website: “The ABA has strongly opposed fair value 

accounting for many years. Our position is that: fair value is appropriate for trading activities or if an institution is 

managed on a fair value basis; fair value is not the most relevant measurement for most financial institutions, since 

we are not managed on a fair value basis; fair value will actually mislead users of banks’ financial statements; it 

would be more appropriate for the FASB to study fair value accounting, determine whether fair value disclosures are 

being used and how they might be improved.” (available at: 

http://www.aba.com/Industry+Issues/GR_FASB_PUB.htm) See also comments of Isaac at October 29, 2008 SEC 

Roundtable. 

287 See Treasury 1991 Bank Report at IX-10. The Treasury report also notes that: 

Banking and thrift regulatory agencies recognize that prudential asset/liability management techniques may 

require the selling of investment securities prior to maturity as part of an overall business plan or to 

effectively manage liquidity and interest rate risk. Under these circumstances, the meaning of ‘intent and 

ability to hold to maturity’ is ambiguous, and the prospect that financial instruments are frequently sold 

prior to maturity substantially limits the usefulness of this concept. 
182

Fourth, that fair value understates the “true economic value” of financial instruments when 

markets are depressed, leading to concerns regarding fair value accounting resulting in “procyclicality.”288 

For purposes of this study, the Staff refers to the term “pro-cyclicality” generally to mean the 

amplification of otherwise normal cyclical business fluctuations. In this context, the concern is 

that reinforcement mechanisms may operate through the financial system to intensify existing 

cyclical business fluctuations and, in turn, cause or exacerbate financial instability. 

Significant concerns have been raised that fair value accounting can induce a pro-cyclical 

downward pressure in asset prices, leading security prices and asset values to fall considerably 

below what some believe is their true “fundamental value.” Further, concerns have been 

expressed about the fact that, in order to offset the write-downs caused by the fair value 

accounting for their investment securities, financial institutions may have been compelled to sell 

securities in illiquid markets (despite the institutions’ original intentions to hold those assets until 

maturity or recovery) or raise capital in a challenging environment. In illiquid or distressed 

markets, these forced sales may further weaken the market for the securities and reduce the 

resulting price for the observed trades, compelling additional sales to raise capital. In such 

markets, otherwise non-distressed sellers would prefer to stay out of the market, leaving the 

market price to be determined based on forced sales, thus continuing to reduce prices and 

inhibiting other non-distressed sellers from entering the market. Some also hold the view that, in 

such markets, the unrealized losses recorded due to fair value accounting may create a loss of 

confidence in investors and analysts, adding uncertainty and a further decline to the market. In 

other words, “headline risks” from disclosure of “bad news” itself influences future behavior. 

Acknowledging these concerns, researchers have begun to apply mathematical models289 and 

simulations290 to assess the potential for a pro-cyclical effect of fair value accounting under 

varying sets of assumptions.291

Many others have, however, expressed the view that the concerns about pro-cyclicality arise 

from the use of financial reporting results for regulatory capital purposes. Those who express 

this view point out that regulatory capital standards, not accounting standards, are established to 

 

288 See, e.g., comment letters from ABA, Cox, Etheridge, Roundtable (November 13, 2008), Highland, Isaac, C. 

Lane, MBA, Schryer, Steinmetz, Tchingambu, and Varley. 

289 See, e.g., Franklin Allen & Elena Carletti, Mark-to-Market Accounting and Liquidity Pricing, 45 Journal of 

Accounting and Economics 2-3 (2008) at 358-378; Guillaume Plantin, Haresh Sapra & Hyun Shin, Marking-toMarket: Panacea or Pandora’s Box?, 46 Journal of Accounting Research 2 (2008), at 435-460; Haresh Sapra, Do 

Accounting Measurement Regimes Matter? A Discussion of Mark-to-Market Accounting and Liquidity Pricing, 45 

Journal of Accounting and Economics 2-3 (2008), at 379-387. 

290 See, e.g., IMF GFSR. 

291 Although the Staff understands that a number of research projects are currently in progress, the Staff has been 

unable to find any publicly available research (as of December 1, 2008) that provides large-scale empirical evidence 

on the potential pro-cyclical effect of fair value accounting. Although there are papers that discuss whether financial 

institutions’ leverage decisions are pro-cyclical, or the potential existence of bubbles (or occasionally potholes) in 

market prices, the analyses in such papers generally tend not to be specific to the application of fair value accounting 

per se. 
183

address capital adequacy of financial institutions. Accounting, rather, should provide accurate 

information for use by investors in capital allocation decisions. 

The objective of SFAS No. 157 and of existing fair value standards is to provide transparent, 

unbiased information about value. That is, the objectives of financial reporting as described in 

SFAC No. 1 “stem primarily from the needs of external users who lack the authority to prescribe 

the information they want and must rely on information management communicates to them,”292

as opposed to the needs of regulatory or oversight agencies. Specific goals regarding prudential 

oversight remain largely outside of the recognized purposes of financial reporting. To fulfill its 

informational role for the investor, financial reporting would generally need to provide neutral 

and unbiased information.293 In fact, as discussed in Section III.D, for prudential oversight 

purposes, regulatory capital requirements begin with financial information provided under U.S. 

GAAP, but are adjusted with the intention of better reflecting the solvency and safety and 

soundness of the institutions on an ongoing basis.294

Others have articulated the belief that fair value accounting is not the underlying cause of the 

current global economic crisis. For example, most of the panelists at the July 9 Roundtable 

indicated that they do not share the view that fair value accounting is pro-cyclical. A number of 

investors have expressed the view that the application of fair value drew greater attention to the 

deteriorating condition of certain financial instruments more quickly than historical cost would 

have.295 Rather, the pro-cyclicality, to the extent it exists, arises from the market effects of 

deleveraging, which is an economic decision. For example, in addition to record rates of poorly 

performing assets as a result of the bursting of the housing bubble, a market aversion developed 

to complex structured products, some of which may have been previously liquid, due to 

uncertainties about their continued performance and a flight to more conventional high-quality 

instruments. Further, institutions that were holding assets on an original short term basis with an 

intent to securitize found their holding duration increased due to the reduced demand for 

securitized products. Those who hold such views suggest that it is more appropriate to instead 

look at the underlying economic causes of the global economic crisis (which may include aspects 

of effective risk management, availability of liquidity, increasing volume of activities in largely 

unregulated financial instruments, and counter-party confidence). 

 

292 SFAC No. 1, paragraph 28. 

293 See SFAC No. 1, paragraph 33. 

294 As discussed in Section III.D, the effects of fair value estimates are excluded for purposes of determining 

regulatory capital under many circumstances. However, losses on assets that are reflected in income and retained 

earnings under U.S. GAAP are generally recognized in regulatory capital. This implies, for example, that the 

unrealized gains and losses resulting from the fair value measurement of AFS debt securities (which are included in 

accumulated OCI) are excluded from regulatory capital, while any OTTI on those securities would not be excluded. 

OTTI on investments can occur, however, even when the investments are measured at amortized cost (as is the case 

with, for example, HTM debt securities). 

295 See, e.g., letters from CAQ, CII, Credit Suisse, ICAEW, ICGN, ITAC, Markit, NASBA, PwC (October 1, 2008), 

as well as comments from Evans at the October 29, 2008 SEC Roundtable and Landsman at the November 21, 2008 

SEC Roundtable. 
184

Even among those who acknowledge potential pro-cyclical effects, some continue to believe that 

fair value accounting should be maintained.296 The Global Financial Stability Report recently 

published by the International Monetary Fund observed that, although there are weaknesses to 

fair value accounting that “may introduce unintended volatility and pro-cyclicality, thus 

requiring some enhancements, it is still the preferred accounting framework for financial 

institutions.”297 The report also concluded that “capital buffers, forward-looking provisioning, 

and more refined disclosures can help to mitigate the procyclicality of [fair value 

accounting].”298 

Summary and discussion 

Considering the available evidence regarding the usefulness of fair value information to 

investors, the suspension of fair value to return to or introduce historical cost-based measures 

would likely increase investor uncertainty and reduce investor confidence. This greater 

uncertainty would likely adversely impact the values of debt and equity securities. In addition, 

this greater uncertainty would potentially increase the degree of information asymmetry among 

market participants, further adversely affecting market liquidity.299 With investors’ already 

heightened risk aversion and uncertainty, a current move to suspend fair value accounting 

information would remove useful information from investors at a time when this information 

continues to be (or may be more) useful to investors.300 In addition, a suspension of fair value 

accounting would not necessarily relieve companies from periodically considering (and 

recognizing) impairment losses relative to historic cost. If asset impairment tests were to be 

considered as part of a suspension of fair value accounting, then the effect would likely be to 

further increase the uncertainty and information asymmetry faced by investors in the face of 

known credit impairments. Instead, the emphasis of the accounting should focus on those acute 

areas where implementation in times of stress, such as inactive or disorderly markets, is 

challenging. 

Another approach that has been suggested is, instead of suspending fair value accounting, 

supplementing fair value measurements with disclosure. Further, because of the subjective 

nature of some fair value estimates, additional disclosures regarding key inputs and uncertainty 

could be expanded. For example, supplemental disclosures could be provided regarding the 

 

296 See, e.g., Fair Value has a Friend in Paulson, The Deal.com, July 31, 2008 (available at: 

http://www.thedeal.com/dealscape/2008/07/fair_value_has_a_friend_in_pau.php) 

297 IMF GFSR, Chapter 3 at page 109. 

298 Ibid.

299 Prior studies find that firms that provide higher level of disclosure have lower levels of information asymmetry. 

For example, Stephen Brown, Stephen A. Hillegeist & Kin Lo, Conference Calls and Information Asymmetry, 37 

Journal of Accounting and Economics 3 (2004), at 343-366, find that firms which choose to continuously host 

conference calls experience a significant sustained reduction in the level of information asymmetry in the equity 

market. Also Stephen Brown & Stephen A. Hillegeist, How Disclosure Quality Affects the Level of Information 

Asymmetry, 12 Review of Accounting Studies 2/3 (2007), at 443-477. 

300 For example, the American Bankers Association clarified that it does “not support an immediate suspension of all 

forms of fair value, because it would result in confusion for both preparers and investors,” noting that an immediate 

suspension of all fair value would result in a lack of available accounting guidance (letter from ABA (November 13, 

2008)). See also letters from CFA Institute (October 1, 2008) and Joint (November 14, 2008). 
185

sensitivity of Level 3 fair value estimates to key model assumptions.301 Alternatively, companies 

could be required to provide the disclosures that were encouraged by the Division of Corporation 

Finance’s “Dear CFO” letters. 

However, by and large, this call for additional voluntary fair value disclosures has not been fully 

answered. Companies do occasionally provide voluntary disclosures in other settings,302 which 

raises the question of why companies might be reluctant to voluntarily provide additional 

information about their Level 2 and 3 fair value disclosures. Litigation risk may be one reason. 

Prior research suggests that litigation risk affects managers’ voluntary disclosure decisions, and 

that litigation risk can sometimes reduce managers’ incentive to provide additional disclosures, 

particularly of forward-looking information.303 This issue would benefit from further study as it 

specifically relates to voluntarily supplementing the current SFAS No. 157 disclosures. 

It is also unlikely that the market would continue to view the placement of fair value information 

in the footnotes and / or voluntary disclosures as equally informative and reliable as the 

recognized values or the mandatory disclosures that they would be replacing. In other words, 

“good disclosure doesn’t cure bad accounting.”304 For example, some studies that have directly 

compared how investors and analysts use recognized versus disclosed fair value information 

suggest individual market participants (including expert analysts) are more likely to integrate (or 

perhaps are likely to more fully integrate) the information into their judgments when the changes 

in fair value are more obvious (e.g., by the recognition and location within the financial 

statements).305 While some suggest that fair value measurements should be placed in the 

 

301 See, e.g., Stephen G. Ryan, Fair Value Accounting: Understanding the Issues Raised by the Credit Crunch 

(White Paper) Council of Institutional Investors (2008). Several comment letters also acknowledged the need for 

improved disclosures surrounding the application of fair value accounting in the absence of liquid markets. See, 

e.g., letters from ITAC, Joint (November 14, 2008), and Credit Suisse. See comments of Evans at the October 29, 

2008 SEC Roundtable for an alternative to recognizing fair values on the face of the financial statements, see letters 

from Waller and Hodge. 

302 For example, some firms voluntarily choose to host a conference call to provide additional useful information to 

investors (Sarah C. Tasker, Bridging the Information Gap: Quarterly Conference Calls as a Medium for Voluntary 

Disclosure, 3 Review of Accounting Studies 1/2 (1998), at 137-167.), while some firms choose to voluntarily 

provide managerial forecasts of upcoming income that are seen to be useful to investors and analysts (Stephen J. 

Baginski, Edward J. Conrad & John M. Hassell, The Effect of Management Forecast Precision on Equity Pricing 

and on the Assessment of Uncertainty, 88 The Accounting Review 4 (1993), at 913-927). 

303 See Stephen J. Baginski, John M. Hassell & Michael D. Kimbrough, The Effect of Legal Environment on 

Voluntary Disclosure: Evidence from Management Earnings Forecasts Issued in U.S. and Canadian Markets, 77 The 

Accounting Review 1 (2002), at 25-50; Paul M. Healy & Krishna G. Palepu, Information Asymmetry, Corporate 

Disclosure, and the Capital Markets: A Review of the Empirical Disclosure Literature, 31 Journal of Accounting and 

Economics 1-3 (2001), 405-440; and comments of Ball at the October 29, 2008 SEC Roundtable. 

304 See Off-Balance Sheet Report, page 108, which attributes the quote to: Remarks by Michael H. Sutton, Chief 

Accountant, SEC, to American Institute of Certified Public Accountants 1996 Twenty-Fourth Annual National 

Conference on Current SEC Developments, December 10, 1996. See also Principles-Based Accounting Study. 

305 See, e.g., D. Eric Hirst & Patrick E. Hopkins, Comprehensive Income Reporting and Analysts’ Valuation 

Judgments, 36 Journal of Accounting Research (Supplement) (1998), at 47-75; D. Eric Hirst, Patrick E. Hopkins & 

James M. Wahlen, Fair Values, Income Measurement, and Bank Analysts’ Risk and Valuation Judgments, 79 The 

Accounting Review 2 (2004), at 453-472; and Anwer S. Ahmed, Emre Kilic & Gerald J. Lobo, Does Recognition 

Versus Disclosure Matter? Evidence from Value-Relevance of Banks’ Recognized and Disclosed Derivative 

Financial Instruments, 81 The Accounting Review 3 (2006), at 567-588. Other research suggests that, following the 
186

footnotes because they are less reliable, some suggest that the choice to disclose (rather than 

recognize) might also lead to further reductions in reliability.306 Therefore, investor uncertainty 

could be negatively affected, even if some companies continue to provide fair value disclosures. 

b. Theme 2 – Modify What is Considered to be a Current Value 

Measure 

Other recent suggestions have included using “fundamental value” accounting methods307 or 

using a “rolling average” of fair values rather than “current” fair values.308 In this section, the 

Staff identifies how variations of these two suggestions appear in current U.S. GAAP in various 

contexts. The Staff further considers the advisability and feasibility of related modifications to fair 

value accounting standards in Section VII.

For purposes of this study, the Staff considers fundamental value (sometimes referred to as 

“value-in-use”) of an asset or liability to mean the measurement of an asset or liability based on 

the estimated future cash flows over its life. Thus, if there is no decline in the expected future 

cash flows over the life of a financial asset, there would be no decline in the asset’s fundamental 

value. However, there are challenges associated with the implementation of a fundamental value 

analysis that could move the concept closer to or further away from fair value under SFAS No. 

157. For example, in implementing a fundamental value model based on an estimate of future 

cash flows, one must consider the rate to use in discounting cash flows. If the rate selected is a 

current market rate, fundamental value and current value will tend to converge. Further, in 

determining what cash flow estimates are reasonable, one must address whether cash flows 

should be based on management’s estimates or the assumption of cash flows implied in the 

market. To the extent cash flow estimates are based upon market assumptions, fundamental 

value will tend to converge with fair value. 

 effective date of SFAS No. 130, investors are more likely to treat OCI items as transitory when reported in the 

statement of changes in equity, rather than in a statement of financial performance. See, e.g., Dennis Chambers, 

Thomas J. Linsmeier, Catherine Shakespeare & Theodore Sougiannis, An Evaluation of SFAS No. 130 

Comprehensive Income Disclosures, 12 Review of Accounting Studies 4 (2007), at 557–593. 

306 See Robert Libby, Mark W. Nelson & James E. Hunton, Recognition v. Disclosure, Auditor Tolerance for 

Misstatement, and the Reliability of Stock-Compensation and Lease Information, 44 Journal of Accounting 

Research 3 (2006), at 533-560. 

307 See, e.g., the September 30, 2008 letter from multiple members of Congress (available at: 

http://www.complianceweek.com/s/documents/SEConFV.pdf); comments of Isaac at the October 29, 2008 SEC 

Roundtable; and letters from ABA (September 23, 2008), ACCU, Haslem, New World, Sigmon, Southwest, 

Tarasuk, and WesCorp. 

308 See, e.g., Newt Gingrich, Commentary: Suspend Mark-to-Market Now!, September 29, 2008, Forbes.com, 

(available at http://www.forbes.com/opinions/2008/09/29/mark-to-market-oped-cx_ng_0929gingrich.html). See 

also Thomas Seeberg, Michael Starkie & Carsten Zielke, Fair Value Move Could Break the Writedown Spiral, 

Financial Times, April 3, 2008, at page 27: 

Our view is that if assets are measured at fair value as at the reporting date, even if the requirements for a 

liquid and orderly financial market are no longer met, then this measurement reflects an erratic market price 

and not fair value. This erratic market price is damaging the economy. In order to escape from this vicious 

circle, and to remain fundamentally self-sufficient in terms of its financial position, Europe must move 

away from reporting date-based measurement of the market price and start measuring the average market 

price over a period. 
187

Notwithstanding the stated preference for observable inputs, fair value under SFAS No. 157’s 

fair value hierarchy is not limited to use of market data to the exclusion of management 

estimates. Level 3 fair value estimates (sometimes referred to as “mark-to-model”) incorporate 

the concept of fundamental value and value-in-use, although based on the anticipated 

assumptions of market participants (i.e., not the company-specific value-in-use). Differences 

may exist, for example, to the extent that market participants’ expectations of the future cash 

flows differ from management’s own expectations. Differences may also exist regarding the 

appropriate discount rate to apply to the estimated future cash flows. For example, the 

computation of fundamental value for a loan loss impairment under SFAS No. 114 applies the 

rate of return implicit in the loan at the time of the loan’s origination or acquisition,309 whereas 

the computation of the Level 3 fair value estimate under SFAS No. 157 could reasonably be 

expected to change as the rate of return is adjusted for market participants’ changing risk 

assessments. Further, discussion of the use of management’s internal assumptions in the 

measurement of fair value, including expected future cash flows, was provided in the joint SEC 

Staff / FASB staff’s press release310 and FSP FAS 157-3. 

Basing a measurement on the concept of a “rolling average” of current prices would dampen the 

impact of value changes by smoothing changes (increases and decreases) into the measure over 

time. Those who support such a model often stress that values go both up and down over time 

and volatility in income is reduced. The concept of a rolling average is often applied in technical 

analysis in finance (albeit to identify trends in movement, not an underlying economic value per 

se).311 However, if implemented, questions would naturally arise about the appropriate length of 

the evaluation period, ranging from short periods covering a single day, longer periods covering 

200 trading days, and suggestions for even longer periods covering three years.312 Similar 

concerns regarding the evaluation period appear to have arisen in the application of OTTI in the 

context of SFAS No. 115, with the corresponding application of judgment. Further, the resulting 

asset “value” on the balance sheet cannot be characterized as anything other than the average 

price and, thus, would likely result in a potential reduction in confidence in the usefulness of 

both income and the balance sheet. 

In addition, implementing these or other similar suggestions would oblige accounting standardsetters to mandate prescriptive rules when the FASB and SEC Staff (and others) have recognized 

the benefits of a move towards principles-based or objectives-oriented accounting standards, 

 

309 As described in paragraph 14 of SFAS No. 114, unless the loan’s interest rate varies contractually with 

subsequent changes in an independent factor (such as an index or rate). 

310 See “SEC Office of the Chief Accountant and FASB Staff Clarifications on Fair Value Accounting,” SEC Press 

Release No. 2008-234 (September 30, 2008). 

311 Technical analysis is a series of techniques used to forecast future price movements based on the analysis of past 

market prices and market volumes using often relatively simple charts and tools, such as trendlines and moving 

averages. It is thought to be the original form of investment analysis, dating back to the 1800s, and coming into use 

before sufficient financial disclosures were required to allow for a more fundamental analysis. See, e.g., William 

Brock, Josef Lakonishok & Blake LeBaron, Simple Technical Trading Rules and the Stochastic Properties of Stock 

Returns, 47 Journal of Finance 5 (1992), at 1731-1764. 

312 See, e.g., Ibid. 
188

minimizing exceptions from the standard and avoiding the use of bright-lines.313 That said, the 

level of misunderstanding and misinterpretation surrounding these issues314 suggests that 

additional guidance and / or additional educational materials surrounding these issues would be 

useful. 

C. Auditing Standards

Issues related to the audit of fair value measurements have, to some extent, been present for 

many years.315 Notwithstanding the recent releases by the PCAOB,316 some views expressed in 

comment letters317 and during the public roundtables318 in conjunction with this study suggest 

that a further look at auditing fair value measurements may be warranted. The Staff understands 

that the PCAOB has begun standard-setting projects on auditing fair value measurements and 

disclosures, as well as auditing accounting estimates and using the work of specialists, among 

other projects.319 The Staff supports and encourages the PCAOB in its ongoing efforts to 

evaluate whether additional auditing standard-setting in this area is appropriate. 

Offering detailed recommendations for auditing standards remains outside of the scope of this 

study. However, the Staff notes, based on the previous discussion regarding the reliability of fair 

value estimates, that concerns about the verification of those values in audits may exist, 

particularly with the application of judgment in illiquid markets and / or regarding Level 3 

measurements in the fair value hierarchy. 

Little research directly examines the verification and attestation of fair value measurements. 

Some researchers have outlined some potential policy considerations that may merit further 

consideration. First, because auditors generally have less training in valuation, specialists are 

often required to audit fair value measurements. Firms may need to re-evaluate the existing audit 

 

313 See, e.g., Principles-Based Accounting Study. 

314 See prior discussion at the beginning of Section VI.B. 

315 See, e.g., Treasury 1991 Bank Report at XI-20-21; and Roger D. Martin, Jay S. Rich & T. Jeffrey Wilks, 

Auditing Fair Value Measurements: A Synthesis of Relevant Research, 20 Accounting Horizons 3 (2006), at 287–

303. 

316 Recent releases regarding fair value include: PCAOB Staff Audit Practice Alert No. 2, “Matters Related to 

Auditing Fair Value Measurements of Financial Instruments and the Use of Specialists” (December 10, 2007); and 

PCAOB Staff Audit Practice Alert No. 3, “Audit Considerations in the Current Economic Environment” (December 

5, 2008). Other relevant auditing guidance includes PCAOB Interim Standard AU Section 328, Auditing Fair Value 

Measurements and Disclosures.

317 See, e.g., letters from Georgetown, CUNA, Roundtable, and S. Smith. 

318 For example, during the July 9, 2008 SEC Roundtable, some preparers and auditors expressed the view that 

applying the concepts in SFAS No. 157 under current market conditions is challenging, stating that additional 

interpretive guidance would be helpful on, among other issues, what represents sufficient evidence for an auditor. 

During the October 29, 2008 SEC Roundtable, some expressed the view that auditors’ preferences for independent 

information may prevent companies from applying aspects of SFAS No. 157 that would require greater application 

of judgment. 

319 See Thomas Ray, Chief Auditor and Director of Professional Standards, PCAOB, Remarks before the 2008 

AICPA National Conference on Current SEC and PCAOB Developments (December 9, 2008). (available at: 

http://www.pcaob.org/News_and_Events/Events/2008/Speech/12-09_Ray.aspx) 
189

team structures and incentives to assess whether the two are compatible with audits requiring 

increased application of specialized valuation knowledge. Second, the internal controls over fair 

value measurements may vary markedly from controls over typical exchange transactions, and 

fair value measurement methods, applications, and controls will likely continue to evolve. 

Auditors will therefore likely need to expend ongoing effort to update their understanding and to 

evaluate controls related to these measurements. Finally, auditors need to be aware of the 

sources of likely errors and biases that might affect preparers’ valuation judgments (such as 

management incentives and over-confidence in relatively limited information) and their own 

judgments when auditing valuation judgments (such as the tendency to search for corroborating 

rather than disconfirming information). These sources of likely errors and biases are not 

necessarily unique to fair value measurements, but are applicable to other accounting estimates 

as well; such applications of judgment would include (but not be limited to) impairment 

judgments, loan loss reserves, and even useful lives for depreciation purposes. As with the 

application of judgment throughout an audit, auditors would need to identify and test the 

reasonableness of key assumptions within the valuation process. 

Judgment is certainly not new to accounting or auditing, with the criteria for making and 

evaluating judgment having been a topic of discussion for many years.320 However, the use of 

fair value and the creation of complex financial instruments (as well as changes in the regulation 

of auditors, and a focus on more objectives-based standards) have extended the bounds of the 

judgments that investors must rely on and accountants and auditors must make. This is 

particularly true for Level 3 fair value measurements, where investors may lack confidence in the 

use of judgment, and preparers may have concerns regarding whether reasonable judgments are 

respected. In recognition of these concerns (along with the potential lack of agreement in 

principle on the criteria for evaluating judgments and concern over the increased use of 

principles-based accounting standards), CIFiR recommended that the SEC should issue a 

statement of policy articulating how it evaluates the reasonableness of accounting judgments and 

include factors that it considers when making this evaluation, as well as that the PCAOB should 

also adopt a similar approach with respect to auditing judgments.321 

 

320 See CIFiR Final Report, at page 88. 

321 See CIFiR Final Report, at page 93 (Recommendation 3.5). 
190
191

VII. Advisability and Feasibility of Modifications to Fair Value 

Accounting Standards 

This section of the study summarizes existing actions taken and underway to address challenges 

in the application of fair value accounting. This section also provides recommendations on the 

advisability and feasibility of modifications to fair value accounting requirements. Specifically, 

this section provides: 

• An overview of the steps taken to date to address accounting issues in the current market 

environment; 

• A description of current accounting standards projects addressing fair value and its 

application in practice; and 

• Recommendations on the advisability and feasibility of modifications. 

Overall, as a result of the analyses in the preceding sections of this study, the Staff believes the 

suspension of fair value accounting (to implement historical cost-based or other alternative 

valuation measures) is not advisable. The suspension or elimination of current accounting fair 

value requirements would likely increase investor uncertainty and adversely impact investor 

confidence by removing access to information at a time when that information is likely most 

useful to investors. 

However, as a general principle, it is always advisable and feasible for accounting standards to 

be reviewed for any needed modifications, enhancements or improvements. The recent 

economic crisis has highlighted challenges in the application of accounting standards related to 

fair value and asset impairments. In response, the SEC and the Boards have engaged in 

extensive consultations with various constituents including investors, preparers, auditors, 

valuation specialists, and industry groups and have issued additional accounting guidance to 

assist application. While these important steps have addressed a number of the immediate 

challenges, the Staff has developed a number of recommendations that should be considered in 

order to improve accounting guidance for fair value measurements (and related asset 

impairments guidance). 

In addition, the global economic crisis has highlighted that our financial markets are becoming 

increasingly global and interconnected. In considering modifications to U.S. GAAP, coordinated 

efforts to the extent practicable should be made with the IASB. As noted in Section I.C, the SEC 

has long recognized that a widely-used single set of high quality globally accepted accounting 

standards could benefit both the global capital markets and investors. A single set of high 

quality accounting standards should continue to be the goal of standard-setters and regulators, 

including when considering modifications to existing accounting standards. Therefore, the 

FASB and the SEC should continue to work closely with the IASB as well as national and 

regional securities regulators towards this goal. 
192

A. Financial Reporting Responses to Global Economic Crisis 

In an effort to address the most pressing issues related to the global economic crisis, the SEC, the 

FASB, and the IASB have taken a number of steps to provide additional guidance and 

clarification related to fair value accounting to marketplace participants. The following is a 

summary of the key actions undertaken related to fair value accounting. 

1. SEC Division of Corporation Finance “Dear CFO” Letters 

In March 2008 and September 2008, the SEC’s Division of Corporation Finance issued 

illustrative letters to financial institutions to alert those institutions to disclosure issues relating to 

fair value measurements they may wish to consider in preparing their filings.322 The first letter 

focused on disclosures related to material unobservable inputs utilized by management in 

developing fair value estimates. The second letter expanded the examples by providing 

additional recommended disclosures related to financial instruments that are not actively traded. 

The purpose of the expanded disclosures was to provide investors with clearer and more 

transparent information regarding fair value measurements, particularly with regard to financial 

instruments that are not currently actively traded and whose effects have had, or are reasonably 

likely to have, a material effect on the financial condition or results of operations. 

2. SEC / FASB Staff Clarifications on Fair Value Measurements 

The SEC’s Office of the Chief Accountant (“OCA”) and the FASB staff issued a joint release on 

September 30, 2008 providing clarifications on fair value accounting.323 Specifically, the 

guidance provided immediate responses to five frequently encountered challenges regarding fair 

value measurements in the current environment with the intention to help preparers, auditors, and 

investors. In addition, the FASB issued FSP FAS 157-3 on October 10, 2008 to provide 

additional real-time guidance on the measurement of the fair value of a financial asset in inactive 

markets. 

3. IASB Expert Advisory Panel 

Consistent with recommendations of the Financial Stability Forum in April 2008, the IASB 

formed an Expert Advisory Panel consisting of preparers, auditors, users and regulators who 

have practical experience with the valuation of financial instruments in the current market 

environment. Based on the work of this expert panel, and after an exposure period for public 

comment, the IASB staff in October issued information and educational guidance for measuring 

and disclosing fair values.324 In addition, the IASB staff issued an accompanying document 

 

322 See March 2008 letter available at http://www.sec.gov/divisions/corpfin/guidance/fairvalueltr0308.htm and 

September 2008 letter available at http://www.sec.gov/divisions/corpfin/guidance/fairvalueltr0908.htm. 

323 See “SEC Office of the Chief Accountant and FASB Staff Clarifications on Fair Value Accounting” SEC Press 

Release No. 2008-234 (September 30, 2008). 

324 See Measuring and Disclosing the Fair Value of Financial Instruments in Markets that are No Longer Active 

(IASB Expert Advisory Panel). (available at: http://www.iasb.org/NR/rdonlyres/0E37D59C-1C74-4D61-A984-

8FAC61915010/0/IASB_Expert_Advisory_Panel_October_2008.pdf ) 
193

regarding the use of judgment in measuring fair value when markets become inactive. This 

shorter document covered four areas of fair value accounting where judgment needs to be 

applied in the current environment including: using prices from inactive markets, forced 

transactions, the use of broker quotes and pricing services, and the use of management 

assumptions. 

4. IASB Fair Value Disclosures

Also in October, the IASB proposed amendments to require companies applying IFRS to include 

additional disclosures similar to those already required by SFAS No. 157.325 Specifically, the 

exposure draft proposes that companies providing disclosures on the measurement of fair value 

for financial instruments include a three-level fair value hierarchy (similar to the disclosures 

required in SFAS No. 157). The IASB has proposed these amendments at the request of users of 

financial statements who have indicated that enhanced disclosures about fair value measurements 

are necessary, especially in light of the current market conditions. The exposure draft was open 

to comments until December 15, 2008, and the IASB is evaluating the comments to consider 

further actions as early as January 2009. 

5. IASB Amendments to IAS 39 and IFRS 7 

In October 2008, the IASB amended IAS 39, Financial Instruments: Recognition and 

Measurement, and IFRS 7, Financial Instruments: Disclosures.

326 The amendments permit nonderivative financial assets held-for-trading and AFS financial assets to be reclassified in 

particular situations. The amendments permit an entity to reclassify non-derivative financial 

assets out of the fair value (through profit or loss) category in particular circumstances. The 

amendments also permit an entity to transfer from the AFS category to the loans and receivables 

category a financial asset that would have met the definition of loans and receivables (if the 

financial asset had not been designated as AFS), if the entity has the intention and ability to hold 

that financial asset. The IASB noted that the reclassification of securities and loans under U.S. 

GAAP is available in certain circumstances and that entities applying IFRS did not have that 

possibility for reclassification. The amendments issued bring IAS 39 more in line with U.S. 

GAAP, particularly SFAS No. 115 and SFAS No. 65. This amendment was effective 

retroactively back to July 1, 2008. 

6. Other-than-Temporary Impairment 

 

On October 14, 2008, the SEC’s OCA, after consultation with and agreement by the FASB staff, 

provided additional guidance regarding OTTI in the context of perpetual preferred securities.327

 

325 See IASB Exposure Draft, Improving Disclosures about Financial Instruments (proposed amendment to IFRS 7). 

The exposure draft comment period ended on December 15, 2008. 

326 See “IASB amendments permit reclassification of financial instruments,” IASB Press Release (October 13, 

2008). (available at: 

http://www.iasb.org/News/Press+Releases/IASB+amendments+permit+reclassification+of+financial+instruments.ht

m) 

327 See letter dated October 14, 2008, from Conrad Hewitt, Chief Accountant, SEC, to Robert H. Herz, Chairman, 

FASB. (available at: http://sec.gov/info/accountants/staffletters/fasb101408.pdf) 
194

Specifically, the guidance indicated that given the hybrid nature of these instruments, the OCA 

staff would not object to an issuer applying an impairment model similar to debt securities. This 

guidance provided greater clarity to preparers who expressed concern that existing guidance 

indicated that the appropriate impairment model would lead one to treat perpetual preferred 

securities like equity. The guidance further indicated that the views of OCA staff should be 

considered an intermediate step in addressing urgent practice issues regarding OTTI, and the 

OCA staff has requested the FASB to expeditiously address those issues that have arisen in the 

application of the OTTI model under SFAS No. 115. 

7. Advisory Group on Financial Reporting Issues Arising from Global 

Economic Crisis 

The Boards also have formed the Financial Crisis Advisory Group (“FCAG”), comprised of 

senior leaders with broad international experience with financial markets, to help consider how 

improvements in financial reporting could help enhance investor confidence in financial markets. 

The group will meet several times during the first half of 2009 and expects to complete its work 

by late July. Issues identified during the roundtable discussions, as well as any other issues that 

may be identified by FCAG, will be given consideration by that group to assist the Boards in 

responding to the crisis in an internationally coordinated manner.328

8. G-20 Summit on Financial Markets and the World Economy329

The Leaders of the Group of Twenty (the “G-20”) met in Washington, D.C. on November 15, 

2008 to discuss the serious challenges facing the world economy and the financial markets. At 

this summit, the leaders of the G-20 agreed that a broader policy response to the current 

economic crisis was needed. The goal of this broader response is based on closer 

macroeconomic cooperation to restore growth, avoid negative spillovers, and support emerging 

market economies and developing countries. As a result, the G-20 agreed upon some immediate 

action steps to achieve these objectives along with five additional reforms that will strengthen 

financial markets and regulatory regimes so as to avoid future crises. The list of additional 

reforms agreed upon by the G-20 included the goal of strengthening transparency and 

accountability within the financial markets. Specifically, the G-20 noted that global accounting 

standards bodies should work to enhance existing guidance on the valuation of complex 

securities in illiquid markets and expand the required disclosures for these assets.330 

 

328 “IASB and FASB Create Advisory Group to Review Reporting Issues Related to Credit Crisis,” FASB Press 

Release (October 16, 2008). (available at: http://www.fasb.org/news/nr101608_2.shtml) 

329 Declaration of the Summit on Financial Markets and the World Economy, November 15, 2008 (available at: 

http://www.whitehouse.gov/news/releases/2008/11/20081115-1.html) 

330 The IASB issued a release after its December meetings on progress toward meeting the G-20 declarations. This 

release included a summary of actions previously discussed in this study, along with other actions taken by the 

Boards. See 

http://www.iasb.org/News/Press+Releases/IASB+provides+update+on+steps+taken+in+response+to+the+global+fi

nancial+crisis.htm. 
195

9. FASB / IASB Roundtables on Global Financial Crisis 

The Boards jointly hosted roundtable meetings during 2008 in London (November 14), 

Norwalk, Connecticut (November 25) and Tokyo (December 3) to provide an opportunity for 

the members of the Boards to hear input from a wide range of stakeholders, including users and 

preparers of financial statements, governments, regulators, and others. The roundtables were 

intended to help the Boards identify accounting issues that may require the urgent and 

immediate attention of the Boards to improve financial reporting and help enhance investor 

confidence in financial markets. The Boards factored that input into their respective decisions 

to add separate and joint short-term projects on impairment to their agendas in December. The 

Boards also sought input from roundtable participants to identify broader financial reporting 

issues arising from the global economic crisis and considered that input in their decisions in 

December to add a comprehensive joint project to address complexity in existing standards of 

accounting and reporting of financial instruments.331

10. Proposed FASB Staff Position on Amendments to EITF Issue No. 99-

20 

On December 19, 2008, the FASB issued an exposure draft of FSP EITF 99-20-a, which would 

include targeted improvements to EITF Issue No. 99-20,332 including improvement to provide for 

the use of judgment in assessing whether an impairment loss is expected to be temporary. 

Specifically the FASB exposed an amendment to paragraphs 12b and 12a to eliminate the notion 

of “market participants” so the impairment requirements under EITF Issue No. 99-20 are more 

closely aligned with impairment requirements under paragraph 16 of SFAS No. 115. This 

exposure draft was issued with an accelerated due process so as to contemplate anticipated 

issuance of a final FSP on January 8, 2009 effective for reporting periods ending after December 

15, 2008. 

11. Project on Disclosures for Certain Financial Instruments 

The Boards are both proposing changes in disclosures to provide more transparency related to 

incurred losses.333 The potential disclosures would require the pro forma effects on pretax 

income as if AFS and HTM debt securities and loans were: (1) carried at fair value with changes 

in fair value through income, and (2) carried at amortized cost with measurement of incurred 

losses. The FASB exposure draft has a proposed effective date for reporting periods ending after 

December 15, 2008 and an anticipated issuance date no later than January 30, 2009. 

 

331 See FASB, Summary of Board Decisions, December 15, 2008 Board Meeting. (available at 

http://www.fasb.org/action/sbd121508.shtml) 

332 See FASB, Proposed FSP No. EITF 99-20-a, Amendments to the Impairment and Interest Income Measurement 

Guidance of EITF Issue No. 99-20. (available at: http://fasb.org/fasb_staff_positions/prop_fsp_eitf99-20-a.pdf)

333 See FASB, Proposed FSP No. FAS 107-a, Disclosures about Certain Financial Assets: An Amendment of FASB 

Statement No. 107. (available at http://www.fasb.org/fasb_staff_positions/prop_fsp_fas107-a.pdf). See also “IASB 

proposes additional disclosures for investments in debt instruments,” IASB Press Release, December 23, 2008. 

(available at: 

http://www.iasb.org/News/Press+Releases/IASB+proposes+additional+disclosures+for+investments+in+debt+instru

ments.htm) 
196

12. FASB Project on Recoveries of Other-than-Temporary Impairments 

(Reversals) 

On December 15, 2008, the FASB added a project to its agenda to issue an exposure draft to 

allow reversal of impairments for debt securities classified as HTM and AFS when sufficient 

evidence demonstrates recovery. The FASB will proceed with this project in conjunction with 

the IASB, and the FASB staff was commissioned to work in connection with efforts at the IASB, 

with an anticipated effective date for fiscal years beginning after December 15, 2008. 

B. Current Projects 

In addition to these immediate actions to address the fair value accounting challenges faced in 

the current environment, the Boards have projects underway to address the role and future 

direction of fair value in financial reporting. Specifically, there are several standard-setting 

projects in process that involve fair value as a measurement attribute, including the following: 

FASB / IASB Joint Projects

• Conceptual Framework Project 

• Financial Statement Presentation Project 

• Reducing Complexity in Reporting Financial Instruments 

• Insurance Contract Project 

IASB Projects

• Fair Value Measurement Project 

These projects when completed may have a significant impact on the use and presentation of fair 

value accounting. A more detailed description of each project is described below. 

1. Conceptual Framework Project 

The use of fair value as a measurement attribute in future accounting standards may be impacted 

by the results of the conceptual framework project. The purpose of this joint project is to 

develop an improved common conceptual framework that provides a sound foundation for 

developing future accounting standards. The Boards feel that such a framework is essential to 

fulfilling their goal of developing standards that are objectives-based, internally consistent, and 

internationally converged and that result in financial reporting that provides the information 

investors need to make decisions. The new framework will build on the existing IASB and 

FASB frameworks and consider developments subsequent to the issuance of those frameworks. 

The Boards are conducting this joint project in eight phases with measurement representing one 

of the early phases. 

Measurement is a critical aspect of financial reporting. However, it is also one of the most 

under-developed areas of the current conceptual frameworks. The overall objective of the new 
197

measurement framework is to fill in the gaps in the existing frameworks so that standard-setters 

will have clear, up-to-date guidance to use in determining the measurement requirements for 

specific accounting standards. The scope of the measurement phase includes developing an 

inventory of possible measurement bases (as discussed in Section I.D), creating a common 

definition for identified measurement bases, evaluating the benefits and drawbacks of each 

measurement basis, and addressing practical measurement issues that occur during the 

development of standards. 

The goal of this process is to create a framework to assist the Boards in the selection of the 

appropriate measurement basis when developing an accounting standard and provide that a 

measurement basis is applied consistently across accounting standards. Furthermore, 

consideration will also be given to whether use of a single measurement basis (such as fair value) 

would satisfy the needs of financial statement users or if some combination of bases (such as fair 

value combined with amortized historical cost) is appropriate. This measurement framework 

will aid standard-setters as they consider improvements to existing accounting standards 

including the use of fair value as the measurement basis for certain assets and liabilities. 

Therefore, it would be advisable for the Boards to consider accelerating its work on this phase of 

the joint project and use those findings as they implement changes, if any, to expand upon 

existing fair value accounting requirements. 

2. Financial Statement Presentation Project 

As previously discussed, the purpose of this joint project is to establish a standard that will guide 

the organization and presentation of information in the financial statements. The results of this 

project will directly affect how the management of an entity communicates financial information 

to users of financial statements and may alleviate some of the issues related to fair value 

accounting that have been noted by commenters. The Boards’ goal is to improve the usefulness 

of the information provided in an entity’s financial statements to help users make decisions in 

their capacity as capital providers. 

The Boards developed three objectives for financial statement presentation based on the 

objectives of financial reporting and the input the Boards received from users of financial 

statements and from members of their advisory groups. Those proposed objectives state that 

information should be presented in the financial statements in a manner that: 

• Portrays a cohesive financial picture of an entity’s activities; 

• Disaggregates information so that it is useful in predicting an entity’s future cash flows; and 

• Helps users assess an entity’s liquidity and financial flexibility. 

On October 16, 2008, both Boards published for public comment a discussion paper, Preliminary 

Views on Financial Statement Presentation.334 The discussion paper is the result of more than 

 

334 See FASB Financial Accounting Series, No. 1630-100, Discussion Paper, Preliminary Views on Financial 

Statement Presentation (October 16, 2008) (available at: 

http://fasb.org/draft/DP_Financial_Statement_Presentation.pdf); and IASB Preliminary Views on Financial 

Statement Presentation (October 2008). (available at: http://www.iasb.org/NR/rdonlyres/92028667-6118-496EB0FE-97F829858B5D/0/DPPrelViewsFinStmtPresentation.pdf ) 
198

two years of discussion by the Boards and consultation with the project’s two advisory groups 

and others on the issues related to financial statement presentation. The discussion paper 

proposes several significant changes to the existing financial statement presentation model. 

a. Segregation of Activities 

The discussion paper proposes a financial statement presentation model that requires an entity to 

present information about the way it creates value (its business activities) separately from 

information about the way it funds or finances those business activities (its financing activities). 

The presentation of assets and liabilities in the business and financing sections would 

communicate the net assets that management uses in its business and financing activities. That 

change in presentation, coupled with the separation of business and financing activities in the 

statements of comprehensive income and cash flows, could make it easier for users to calculate 

key financial ratios for an entity’s business activities or its financing activities. 

b. Reconciliation of Cash Flow to Comprehensive Income 

The proposed presentation model also would include a new schedule (to be included in the notes 

to the financial statements) that would reconcile cash flows to comprehensive income. This 

reconciliation schedule would disaggregate income into cash, accruals (other than 

remeasurements), and remeasurement components (e.g., fair value changes). The Boards believe 

that this disaggregation of comprehensive income would be helpful because users have asked for 

information to help them understand how components of accrual accounting affect an entity’s 

comprehensive income and future cash flows. 

The discussion paper particularly notes that this reconciliation schedule should provide more 

transparency about the use of fair value. Users have indicated that they believe it is difficult to 

evaluate fully fair value effects given the commingling of gains or losses from fair value 

remeasurements and other components of comprehensive income. The separate presentation of 

those income components in the reconciliation schedule should enable a more effective analysis. 

c. Disaggregation of Assets / Liabilities Measured on Different 

Bases 

Today, under both IFRS and U.S. GAAP, assets and liabilities are measured on several different 

bases, resulting in a mixed-attribute model. The Boards decided that presenting items in an 

entity’s statement of financial position separately according to the basis on which they are 

measured would be consistent with the disaggregation objective because the additional 

information will help users in assessing the amount, timing, and uncertainty of an entity’s future 

cash flows. Therefore, the Boards propose that an entity should not combine similar assets or 

similar liabilities measured on different bases into a single line item in the statement of financial 

position. For example, an entity should not aggregate investments in debt securities measured at 

amortized cost and investments in debt securities measured at fair value and present the total in a 

single line item. This disaggregation can enable investors to better understand the impact that 

fair value has on the financial position and future cash flow capability of a company. 
199

3. Reducing Complexity in Reporting Financial Instruments 

In 2008, the Boards issued for comment a discussion paper regarding reducing complexity in 

reporting financial instruments.335 The purpose of the discussion paper was to address concerns 

expressed by preparers, auditors, and users of financial statements that the reporting for financial 

instruments is too complex. The paper is designed to gather information to assist the Boards in 

deciding how to proceed in developing new standards that are more objectives-based and less 

complex than today’s requirements. This paper also discusses the main causes of complexity in 

reporting financial instruments along with possible intermediate and long-term approaches to 

improving financial reporting and reducing complexity. Overall, the document suggests that one 

long-term solution to address the complexity would be for the reporting of all types of financial 

instruments on a consistent basis. Further, the document states that fair value seems to be the 

appropriate measure for all types of financial instruments. However, there are challenges that 

necessarily need to be addressed by the Boards for such an expansion of fair value 

measurements. 

Many of the challenges to be addressed are highlighted in this study, and one of the key issues to 

be resolved is the development of an enhanced reporting model. The Boards will evaluate the 

need to complete further work on presentation and disclosure issues before introducing a general 

fair value measurement requirement for all financial instruments. 

4. Insurance Contracts Project336

On August 2, 2007, the FASB issued an Invitation to Comment entitled Accounting for 

Insurance Contracts by Insurers and Policyholders. The Invitation to Comment included a 

discussion paper issued in May 2007 by the IASB that sets forth preliminary views on the main 

components of an accounting model for an issuer’s rights and obligations (assets and liabilities) 

under an insurance contract. The objective of this joint project is to develop a common, highquality standard that would address recognition, measurement, presentation, and disclosure 

requirements for insurance contacts. Specifically, this project is intended to: 

• Improve and simplify the financial reporting requirements for insurance contracts; 

• Eliminate numerous pieces of current U.S. accounting literature that add to the complexity of 

accounting for insurance contracts; and 

• Provide investors with more decision-useful information. 

 

335 See Financial Accounting Series No. 1560-100, Invitation to Comment, Reducing Complexity in Reporting 

Financial Instruments (Including IASB Discussion Paper, Reducing Complexity in Reporting Financial Instruments) 

(March 28, 2008) (available at: http://www.fasb.org/draft/ITC_Financial_Instruments.pdf); and IASB Discussion 

Paper, Reducing Complexity in Reporting Financial Instruments (March 2008) (available at: 

http://www.iasb.org/NR/rdonlyres/A2534626-8D62-4B42-BE12-

E3D14C15AD29/0/DPReducingComplexity_ReportingFinancialInstruments.pdf). 

336 Information on the Invitation to Comment and project updates are available at: 

http://fasb.org/project/insurance_contracts.shtml. 
200

The discussion paper also proposes that the measurement attribute for all insurance liabilities 

should be “current exit value” or the amount that the insurer would expect to pay at the reporting 

date to transfer its remaining contractual rights and obligations immediately to another party. 

While the IASB does not propose the use of fair value as the measurement attribute for insurance 

contracts, the definition of current exit value in the discussion paper is similar to the definition of 

fair value in SFAS No. 157. 

5. IASB’s Fair Value Measurement Project337

The IASB is currently developing an exposure draft of an IFRS on fair value measurement 

guidance. The IASB plans to publish an exposure draft in the first half of 2009. The IASB is 

undertaking this project for the same reasons that the FASB issued SFAS No. 157. That is, IFRS 

require some assets, liabilities and equity instruments to be measured at fair value. However, 

guidance on measuring fair value has been added to IFRS on a standard-by-standard basis over 

several years as the IASB or its predecessor decided that fair value was the appropriate 

measurement basis in a particular situation. As a result, guidance on measuring fair value is 

dispersed across a number of standards and it is not always fully aligned. Furthermore, the 

current guidance does not provide a single, clearly articulated measurement objective (such as 

exit value under SFAS No. 157) and does not provide for a standardized measurement hierarchy. 

The IASB believes that this adds unnecessary complexity to IFRS and contributes to diversity in 

practice. In preparing an exposure draft, the IASB has indicated that it will consider the 

requirements of SFAS No. 157. 

C. Recommendations and Related Key Findings 

1. Recommendation – SFAS No. 157 Should Be Improved, but Not 

Suspended

While some have suggested that SFAS No.157 should be suspended, the Staff does not believe 

that the suspension of this standard is advisable. However, as discussed in other 

recommendations, the Staff believes that further improvements to the existing application of fair 

value are necessary. 

As discussed earlier in this study, SFAS No. 157 does not establish any requirements to account 

for assets or liabilities at fair value. Rather, SFAS No. 157 establishes a common definition of 

the term fair value for financial reporting and provides for expanded disclosures in cases where 

preexisting standards require (or in some cases permit) the use of fair value. Accordingly, a 

suspension of SFAS No. 157 would remove the standardized measurement and disclosure 

requirements without removing the requirement (or choice) to account for assets or liabilities at 

fair value. As a result, the suspension of SFAS No. 157 would not reduce the use of fair value as 

a measurement attribute in financial accounting. 

 

337 Project updates are available at: 

http://www.iasb.org/Current+Projects/IASB+Projects/Fair+Value+Measurement/Fair+Value+Measurement.htm. 
201

Without SFAS No. 157, issuers would return to practices that existed prior to the issuance of the 

standard. These practices were based on varying definitions of fair value throughout U.S. GAAP 

and relied upon the limited or conflicting guidance available for applying those definitions. 

Further, suspending SFAS No. 157 would reduce the comparability and consistency of fair value 

measurements currently being performed and therefore hinder investors’ ability to obtain 

decision-useful information on a consistent basis from financial statements. 

Further, the analysis in Section II.B indicates that SFAS No. 157 did not result in an increase in 

the use of fair value. For example, in 2006 (prior to the issuance of SFAS No. 157) financial 

institutions studied reported approximately 42% of assets at fair value in the balance sheet. In 

2008, subsequent to the full adoption of SFAS No. 157, this sample group reported 

approximately 45% of assets at fair value on the balance sheet. While there is an increase of 3%, 

it is important to note that the Staff’s analysis indicated that the FVO in some circumstances 

appears to account for this expanded use of fair value as a measure. 

In analyzing the adoption of SFAS No. 157 as indicated in Section II.B, applying the common 

definition of fair value provided in SFAS No. 157 did not appear to result in a significant 

reporting impact in the financial statements upon adoption. Based on this study, 70% of issuers 

reported no impact upon adoption of SFAS No. 157, and no issuers in this study reported an 

impact greater than 5% of equity at the time of adoption. Further, disclosure of the prospective 

impact of SFAS No. 157 often was not provided in sufficient detail to determine whether there 

was an ongoing incremental impact, as such disclosure is generally provided only to the extent 

the impact is material. Accordingly, the absence of specific disclosure at the vast majority of 

institutions studied would indicate that the impact of adoption was not significant at those 

institutions. 

2. Recommendation – Existing Fair Value and Mark-to-Market 

Requirements Should Not Be Suspended 

The Staff does not believe that a suspension or elimination of existing fair value and mark-tomarket accounting requirements is advisable. 

The existing fair value and mark-to-market requirements were developed over several decades, 

in some cases to specifically address perceived weaknesses identified as a result of prior 

challenging market conditions or events. These standards were subject to extensive due process. 

The abrupt elimination of fair value and mark-to-market requirements would erode investor 

confidence in financial reporting. Further, existing accounting standards generally require markto-market accounting only for certain derivatives and investments that financial institutions hold 

for “trading” purposes (those assets where management has indicated an intent to actively trade 

assets). Thus, mark-to-market accounting is often required for only a minority of investments. 

For the financial institutions analyzed, this study indicated that, on average, approximately 50% 

of broker-dealer, 22% of bank, 7% of GSE, 3% of insurance company, and 1% of credit 

institution assets are marked-to-market. Certain investments other than trading assets and 

derivatives (typically investments in securities that financial institutions do not have the intent 

and ability to hold to maturity) are required to be reported in the balance sheet at fair value. 
202

Unrealized gains and losses on these securities are not recognized in the income statement unless 

the assets are sold or are determined to be impaired. 

Our detailed analysis of bank failures indicates that for substantially all failed banks studied, fair 

value accounting was applied to only a small minority of assets, and losses recorded as a result of 

applying fair value accounting did not have a significant impact on the banks’ capital. While the 

application of fair value varies among these banks (and is generally more extensive at larger 

institutions that engage in trading activities), in each case studied it does not appear that the 

application of fair value can be considered to have been a proximate cause of the failure. 

It is important to note that the role of accounting standards is to provide transparent information 

to investors as they make decisions. Accordingly, the primary factor to consider when 

evaluating the role of fair value accounting is the impact of such accounting on the information 

provided to investors. Based upon the analysis performed in Section IV (including the views 

obtained from investors during multiple roundtables, through comment letters and the 

consideration of existing academic research), investors generally have found existing fair value 

accounting standards, particularly as they relate to fair value accounting for financial 

instruments, to have increased the quality of information available to them. While certainly the 

views of investors are not monolithic, in general, investors have indicated that fair value provides 

more relevant information, reflecting current economic reality that should not be replaced by 

other alternative accounting measures. Many investors indicated that investor confidence is 

reinforced by providing transparency relating to the underlying asset value of their investments, 

and a removal of that information would, in fact, lead to additional financial instability. 

While investors have generally found fair value useful, they have also indicated a need to 

consider improvement to existing practice, including reconsideration of impairment standards, 

and the application of SFAS No. 157 to illiquid investments. Further, investors have 

acknowledged the need for additional measures related to assisting in the understanding of the 

impact of fair value through presentation and disclosure improvements. 

3. Recommendation – Additional Measures Should Be Taken to 

Improve the Application of Existing Fair Value Requirements 

 

While the Staff does not recommend a suspension of existing fair value standards, the Staff 

believes that a number of measures should be taken to improve the application and practice 

related to existing fair value requirements (particularly as they relate to both Level 2 and Level 3 

estimates) including: 

• Considering the need for additional application guidance or best practices for determining 

fair value in illiquid or inactive markets; 

• Enhancing existing disclosure and presentation requirements related to the effect of fair value 

in the financial statements; 

• Educational efforts, including efforts to improve the application, where appropriate, of 

reasonable judgment and analysis in the determination of fair value estimates; 
203

• Examination by the FASB of the impact of liquidity in the measurement of fair value, 

including whether additional application and / or disclosure guidance is warranted; and 

• Assessment by the FASB of whether the incorporation of a company’s own credit risk in the 

measurement of liabilities provides decision-useful information to investors, including 

whether sufficient transparency is provided currently in practice. 

In developing SFAS No. 157, the FASB set out to create an objectives-based standard that would 

allow for the use of judgment in determining fair value. The Staff found that issuers and auditors 

have faced challenges with the application of the standard in the current global economic crisis. 

As previously discussed, the Staff, the FASB, and the IASB have taken several steps to provide 

application guidance to alleviate confusion and to foster reasonable application of fair value 

measurements in the marketplace. However, the Staff believes additional assistance in the form 

of guidance, education, and training is warranted in several areas. Examples include further 

tools to make judgments regarding: 

• How to determine when markets become inactive 

• How to determine if a transaction or group of transactions is forced or distressed 

• How and when should illiquidity be considered in the valuation of an asset or liability 

• How should the impact of a change in credit risk on the value of an asset or liability be 

estimated 

• When should observable market information be supplemented with and / or reliance placed 

on unobservable information in the form of management estimates 

• How to confirm that assumptions utilized are those that would be used by market participants 

and not just by a specific entity 

In determining how to address the above issues, the FASB should consider which issues could be 

resolved through a review of the objectives of SFAS No. 157 and which issues would be best 

addressed by the valuation community. It is noted that the FASB’s VRG and the IASB’s Expert 

Advisory Panel have already discussed many of these items and may be best equipped to 

recommend immediate guidance to the Boards on these issues. Further, the FASB should 

consider working with valuation and appraisal associations and organizations to develop 

additional valuation guidance and best practice documents to assist preparers and valuation 

specialists in performing valuations for financial reporting purposes. Further, the Staff 

recommends that the FASB consider whether changes to how the FASB uses the VRG, including 

whether the FASB should expand the role of the VRG to function more like the FASB’s EITF, 

the use of subcommittees for specific issues, and increasing the openness of the process through 

public meetings, would be beneficial in fostering a common understanding in practice of the 

challenging issues considered by the VRG. 
204

The Staff also believes that it is advisable that the FASB continue efforts to address fair value 

measurement issues related to the valuation of liabilities. It is the Staff’s view that the current 

guidance regarding the measurement of liabilities at fair value has the potential to result in 

confusion in the marketplace and additional consideration in this area is warranted. For example, 

the application of SFAS No. 157 to liabilities has been a significant concern to certain 

constituents. Market participants have expressed concern regarding the recognition of a gain due 

to a decline in the creditworthiness of a debt issuer when the issuer has the intent and ability to 

continue to make all interest and principal payments. Further, constituents have indicated that 

there is diversity in interpretation of the language in the standard. On January 18, 2008, the 

FASB issued a Proposed FSP FAS 157-c, Measuring Liabilities under SFAS No. 157. This FSP 

indicated that in the absence of a quoted price for the identical liability in an active market, the 

reporting entity may measure the fair value of its liability at the amount that it would receive as 

proceeds if it were to issue that liability at the measurement date. Subsequent to the issuance of 

this draft FSP, the FASB received numerous comments from various constituents and is 

currently evaluating its next steps. 

4. Recommendation – The Accounting for Financial Asset Impairments 

Should be Readdressed 

The Staff recommends that the FASB reassess current impairment accounting models for 

financial instruments. The evaluation should consider the narrowing of the number of models 

that currently exist in U.S. GAAP. In conjunction with evaluating current impairment guidance, 

consideration should be given to increasing the prominence of OCI by requiring a separate 

statement or presentation on the face of the income statement. Further, the utility and 

consistency of information provided to investors should be improved, including the 

implementation of measures to provide investors with insight into management’s expectations of 

probable cash flow declines. 

During the course of our study, the accounting for impairment was identified as one of the most 

significant areas of necessary improvement. As noted earlier, as part of its guidance on perpetual 

preferred securities, the Staff requested the FASB expeditiously address issues that have arisen in 

the application of the impairment model in SFAS No. 115. This request was a response to 

challenges encountered in the application of existing OTTI guidance in the current market and 

the complexity created by multiple impairment models for financial instruments. 

One of the most significant concerns expressed in this area is the fact that under existing U.S. 

GAAP, there are multiple sets of impairment rules for financial instruments. The model applied 

often depends on the characteristics of the financial instrument at the date of acquisition, and the 

models are not always consistent with the reporting of impairments for other non-securitized 

investments (such as direct investments in mortgage loans). In the absence of uniform 

accounting treatment for impairments, investors are provided with information that is not 

recognized, calculated or reported on a comparable basis. Further, the treatment of impairments 

for investments under U.S. GAAP is not consistent with the reporting of impairments under 

IFRS. U.S. GAAP also requires that once an impairment is recorded, future increases in value 

(e.g., when the market price recovers) cannot be reported in income until the security is sold. 

IFRS currently requires, for certain investments, the recognition of increases in value in income 
205

when prices recover. The Staff believes that a reconsideration of impairment standards should 

also include a reconsideration of this preclusion. Further, the Staff notes that the Boards have 

already initiated efforts to address this concern. 

The development of a single model addressing the accounting for impairments could reduce the 

complexity and increase the comparability of financial statements. The FASB should evaluate 

the need for modifications (or the elimination) of current OTTI guidance to provide for a more 

uniform system of impairment testing standards for financial instruments. While there are a 

number of alternative models that the FASB should consider, several commenters have 

suggested the development of a model that would require recognizing impairments through 

income related only to credit losses (calculated on an incurred loss basis consistent with 

impairments on loans), while the remaining decline in fair value of an investment (the portion 

that is not related to incurred losses) would be recognized in OCI. The Staff believes that this 

model has the potential to provide investors with both fair value information as well as 

transparent information regarding the cash flows management expects to receive by holding 

investments, rather than through accessing the market currently. That is, such a model would 

appear to help bridge the gap between the current fair value and the value expected from holding 

investment positions until markets return to normal liquidity levels. Other models, including the 

elimination of OTTI in favor of more prominent reporting of impairments in OCI, should also be 

evaluated. Further, in reassessing impairment the FASB should consider whether the “ability 

and intent to hold to recovery” test under SFAS No. 115 is sufficiently operational, including 

whether the operation of the model in practice is consistent with the notion of an AFS security. 

5. Recommendation – Implement Further Guidance to Foster the Use of 

Sound Judgment 

The Staff believes that it is advisable that the SEC and PCAOB consider whether statements of 

policy related to the application of judgment in making fair value measurements would be 

appropriate. 

As indicated in Section II.B, approximately 85% of assets reported at fair value by financial 

institutions studied are reported in Levels 2 and 3 (76% and 9%, respectively). The estimate of 

value for these assets is therefore not based solely on quoted market prices. Rather, information 

derived for observable inputs (in the case of Level 2) and significant unobservable inputs (in the 

case of Level 3) are incorporated into models in developing an estimate of value. Such 

estimation processes, by their nature, require exercise of significant judgment. For 

measurements of fair value, the relevance of historical information, if any, to an expectation of 

future performance can be difficult to determine. Without relevant current information, 

accountants are faced with challenges in evaluating expectations of future events based on 

uncertain forecasts. 

The use of judgment in accounting, auditing and regulation has increased due to the focus on 

more objectives-based standards (such as SFAS No. 157) and increased use of fair value 

estimates. Guidance regarding the application of judgment in connection with fair value 

measurements should keep pace with this increased use. In its final report, CIFiR recommended 

that the SEC issue a statement of policy articulating how it evaluates the reasonableness of 
206

accounting judgments, including the factors that it considers when making this evaluation.338 

Furthermore, this recommendation included a suggestion that the PCAOB should also adopt a 

similar approach with respect to auditing judgments. 

6. Recommendation – Accounting Standards Should Continue to Be 

Established to Meet the Needs of Investors 

Financial reporting is intended to meet the needs of investors. While financial reporting may 

serve as a starting point for other users, such as prudential regulators, the Staff recommends that 

U.S. GAAP should continue to be developed to satisfy the needs of investors. 

The objective of general purpose financial reporting is to provide decision-useful information to 

investors. That is, consistent with SFAC No. 1, the objective of financial statements is to 

provide information to external parties that do not have the ability to otherwise dictate the form 

and content of such information. This view was reinforced by CIFiR’s conclusions on the 

importance of investors to financial reporting. For example, CIFiR noted “most importantly, we 

believe that the financial reporting system would be best served by recognizing the pre-eminence 

of the perspectives of investors because they are the primary users of financial reports.”339 

While financial reports prepared using U.S. GAAP are without a doubt valuable tools considered 

by other users of information, U.S. GAAP should not be established or modified to serve the 

needs of others at the expense of investors. This is particularly true in situations where the other 

users of financial information have the ability to dictate the form and content of such 

information. However, the Staff did not consider and therefore is not making any 

recommendations as to the appropriate form and content of information provided to other users, 

for example, prudential regulators. 

Lastly, to the extent that the interaction of fair value accounting and regulatory capital 

requirements has resulted in concerns about pro-cyclicality (including whether accounting 

standards are resulting in the sale of assets or the need to raise capital in down markets), such 

concerns should not be addressed through changes in accounting standards that would reduce 

investor confidence. 

7. Recommendation –Additional Formal Measures to Address the 

Operation of Existing Accounting Standards in Practice Should Be 

Established 

The Staff recommends that additional formal measures should be adopted to facilitate the 

identification and resolution of issues encountered in the application of existing accounting 

standards in practice, including: 

• Implementing CIFiR’s recommendation for an FRF; 

 

338 See CIFiR Final Report, at page 13 (Recommendation 3.5). See also pages 88-96. 

339 CIFiR Final Report, at page 4. 
207

• The implementation by the FASB of a post-adoption review process; and 

• The establishment of a formal policy for standard-setting in circumstances that necessitate 

near-immediate response. 

The accounting profession has always been associated with independence and neutrality. 

An occasionally-overlooked aspect of the independence of the accounting profession is the 

important role of the independent standard-setter. Standard-setting that solicits input and 

feedback from all interested parties, yet places the interests of no particular party above the needs 

of investors relying on the standards, is critical to investor confidence. 

While independence is a crucial aspect of the accounting standard-setting process, also important 

is the need for a process that addresses challenges identified in practice in applying such 

standards. Not only is it fundamentally important to support the critical independence of these 

bodies for investor confidence, that confidence also is dependent upon the standard-setters’ 

ability to respond timely to real world challenges. Similarly, investors must have confidence in 

those standards and the process used to establish the standards. Open due process, including 

thoughtfully considering the input and views of investors and the many others who participate 

and play a role in our capital markets, is critical to the Boards in fulfilling their mission of 

establishing and improving financial accounting and reporting standards. 

While the Staff believes that the FASB standard-setting process works well, the Staff notes that 

CIFiR has identified enhancements that, if adopted, could result in improvements to the process. 

The current market events and the financial reporting challenges faced by issuers have 

highlighted the need for further consideration of measures to strengthen communications 

between market participants dealing with financial reporting matters. Accordingly, the Staff 

believes that it is advisable to quickly move to implement CIFiR’s recommendation related to the 

creation of the FRF. CIFiR recommended that the FRF include key constituents from the 

preparer, auditor, and investor and other user communities, to meet with representatives from the 

SEC, the FASB, and the PCAOB to discuss issues in the financial reporting system overall, both 

immediate and long-term, and how individual constituents are meeting these challenges.340 

Further, challenges encountered in the application of existing accounting standards have 

highlighted the advisability of formalizing a post-adoption review process for all major FASB 

standards. In that regard, CIFiR recommended that the FASB should conduct post-adoption 

reviews of major standards to identify unintended consequences or other practice issues.341 The 

purpose of the post-adoption review is to ensure new standards are conveying the intended 

information at an acceptable cost and within a reasonable range of differing interpretations 

across companies. CIFiR did not recommend a specified time period for conducting postadoption effectiveness reviews, as it stated that the standard-setter and its advisory groups should 

evaluate the facts and circumstances surrounding each major project when making such 

determinations. 

 

340 See CIFiR Final Report, at page 11 (Recommendation 2.3). 

341 See Ibid.
208

Lastly, the Staff recommends that the FASB establish a formal policy for standard-setting in 

circumstances that necessitate near-immediate response. While the FASB has discretion to 

determine the period for which development-stage accounting literature is exposed for public 

comment, recent economic conditions prompted the FASB to alter its typical due process in 

order to provide timely guidance. These events suggest the FASB should consider establishing a 

formal policy for standard-setting in circumstances in which due process is expedited as such a 

policy would equip the FASB to respond to exigent circumstances that necessitate nearimmediate standard-setting. 

8. Recommendation – Address the Need to Simplify the Accounting for 

Investments in Financial Assets 

The Staff recommends the continued joint work by the Boards to simplify the accounting for 

investments in financial instruments. 

Section I.B provides a brief summary of the existing accounting landscape for investments 

typically held by financial institutions. While the overview in that section is only a summary, it 

nonetheless illustrates the complexities of existing U.S. GAAP. While some of the complexity 

exists as a result of the complex nature of the underlying transactions, much of this complexity 

arises from the multiple models that exist, including the continued reliance on models to 

accommodate mixed-attribute accounting for financial instruments. 

A common theme at the SEC’s roundtables and in comment letters is that the accounting for 

financial instruments can be challenging and that current financial reporting standards for such 

investments are complex. The Staff also heard from investors that understanding the resulting 

financial reports also can be difficult. Such complexity is illustrated by the challenges faced by 

the Staff in assessing the impact of the mixed-attribute model on the balance sheet and income 

statement of financial institutions. 

Accordingly, the Staff believes that it is advisable for the Boards to work to simplify the 

accounting for investments in financial instruments, including the continued exploration of the 

feasibility of reporting all financial instruments at fair value. However, significant obstacles 

continue to exist related to such a move, including concerns about the degree of relevance and 

reliability, and concerns about how changes in fair value should be recognized in the income 

statement. That is, many continue to believe that holding gains and losses (unrealized items) 

have a different character than realized gains and losses. This appears to be particularly true 

during times when the value of securities is impacted significantly by declines in liquidity. 

The Staff believes that it is advisable to address these and other obstacles prior to any significant 

expansion to mandate the use of mark-to-market accounting for assets other than trading assets 

and derivatives. In order to address these challenges, the Boards should expedite their efforts 

around financial statement presentation and disclosure, particularly the joint presentation project 

that is scheduled to be completed by 2011. The joint project on the presentation of financial 

statements should serve to clarify for investors where, and how, fair value impacts a company’s 

financial condition and its operating performance by distinguishing changes in fair value from 

other components of income. 
209

In this regard, the Boards should work closely with the Staff to explore the complete integration 

of interactive data as a tool to bridge the gap between historical cost measures and fair value. 

Moreover, sensitivity disclosures of fair value estimates – as well as appropriate supplemental 

measures that management could elect to provide, for instance HTM valuations of certain debt 

instruments – could position investors to make more informed decisions about capital allocation. 

In this regard, the Boards should work closely with the Staff to explore the complete integration 

of interactive data with respect to these disclosures. 

Lastly, as noted earlier, the Staff recommends that the Boards complete the measurement phase 

of the conceptual framework project in order to inform future decisions about appropriate 

measurement attributes in accounting standards. 
210
211

Appendices 

Index of Appendices

A. Summary of Comment Letters Received as Input to this Study 

B. Participants in SEC Roundtables on Fair Value Accounting 

C. Illustration of Revised Financial Statement Presentation to Segregate Amounts by 

Measurement Attributes, as Proposed by CIFiR 

D. FASB and FAF Members (2008)

A-1

Appendix A - Summary of Comment Letters Received as Input to 

this Study 

I. Overview 

On October 8, 2008, the SEC requested public comment in connection with this study on fair 

value accounting applicable to financial institutions, including the effects of “mark-to-market” 

accounting, under the Act. In response, the Staff received 186 comment letters regarding fair 

value accounting in general, as well as specific areas of focus in this study on fair value 

accounting.342 

In general, there were 56 commenters343 who expressed overall support for fair value accounting 

as a measurement basis used in financial reporting. However, 49 commenters,344 including some 

who were generally supportive, expressed specific concerns surrounding the use or application of 

fair value in financial reporting. Concerns expressed included, but were not limited to, the 

application of fair value for specific assets or liabilities, the role of fair value for purposes of 

measuring impairment as well as overall consistency in measuring fair value including 

measurements in inactive or illiquid markets. These observations, among others, are highlighted 

throughout this summary. 

In addition, a number of commenters345 expressed overall concern over the use of fair value as a 

measurement basis for financial reporting while other commenters346 expressed specific concerns 

over the use of fair value as a measurement basis for assets which do not trade in active markets. 

 

342 This number reflects comments received through December 15, 2008. See Exhibit A.1 for a list of comment 

letters received. Full text of these comment letters is available at http://www.sec.gov/comments/4-573/4-573.shtml 

(file number 4-573). 

343 See letters from Roundtable, Joint, Towers, ITAC, UN-L, BUSL Students, Credit Suisse, ICAEW, Fastiggi, 

Evans, ABA, Edgtton, Ryan, Morfesis, Hale, Montroy, Keating, King, Steinbacher, Phillips, Pigg, Petersen, 

Sleeping Bear, CFA, NASBA, IPS, ACLI, Evans, PwC, Corporate One, Younger, S. Smith, Benson, Gichini, 

Anonymous, Bucalo, AI/ASFMRA, CII, Gueye, New World, Houlihan, Georgetown, ICGN, Markit, MBIA, CAQ, 

Nationwide, Landsman, A. Hamilton, ICI, Rogers, Xylos, Schneider, O’Malley, BAI, and Pink OTC. 

344 See letters from Roundtable, Towers, ITAC, UN-L, BUSL Students, Credit Suisse, Fastiggi, Spicer, Evans, ABA, 

Edgtton, Ryan, Morfesis, Hale, Montroy, Keating, King, Pigg, Petersen, Haslem, Members United, SunCorp, 

WesCorp, ACCU, Central, ACLI, Corporate One, Bachus, Saidens, Southwest, Anonymous, New World, Houlihan, 

Georgetown, ICGN, FHLBC, MBA, Citi, MBIA, CAQ, Nationwide, Levin, Rembert, FHLBA, Straka, Rogers, 

Xylos, O’Malley, and BAI. 

345 See letters from Fischer, Hamilton, Waller, Steward, Etheridge, Carl, Sigmon, Vetter, Foster, Miller, Varley, 

Jeremiah, Viets, Smith, A. Anderson, Cox, Gorton, Cross, Piper, Olson, Owen, Armstrong, Walker, Davis, Harmon, 

Kent, Murray, Leavitt, Kleist, Knorr, Hodge, C. Lane, Eagle, Isaac, Highland, Grossman, IBAT, CBAI, MIBA, 

BankLogic, ICBA, Haley, Bucks County, Nguyen, Lofgreen, PACB, Square 1, IBC, and Anonymous II. 

346 See letters from Tarasuk, Evans, Roundtable, Cannon, BridgePoint, Evans, Micheletti, IPS, Corporate One, 

Carmony, Partnership Consultants, Southwest, Highland, BNP, Quigley, Sconyers, and Risgaard. 
A-2

II. Effects of Fair Value Accounting Standards on Financial Institutions’ Balance 

Sheets 

Two commenters347 expressed a view that the application of SFAS No. 157 to assets and 

liabilities that are recognized and measured at fair value results in a distorted picture of a 

financial institution’s balance sheet and income. These commenters noted that when there is an 

illiquid or inactive market, the values become distorted since they are based on short-term 

market fluctuations, rather than on the true value of assets, particularly for those assets that are 

held for the long-term. 

One commenter348 noted that the effects of fair value on the balance sheet will tend to reflect the 

different stages of the economic cycle and should be judged against the objective of the 

accounting standards, which is to provide relevant information to investors. This commenter 

expressed a belief that the debate over fair value accounting should be disconnected from the 

need for perhaps a different measurement basis, for purposes of determining regulatory capital 

adequacy. 

Another commenter349 provided general observations over the difficulties encountered when 

applying fair value accounting to assets held by financial institutions. More specifically, this 

commenter observed that the exit price concept in SFAS No. 157 may not be appropriate if the 

strategy of management is to hold the security in the near term. In addition, this commenter 

highlighted that fair value measurements are challenging when markets become less active or are 

inactive. Further, this commenter noted that the application of fair value accounting results in 

significant volatility to the balance sheet and contributes to higher volatility of reported income. 

III. Impact of Fair Value Accounting on Bank Failures in 2008 

Some commenters350 expressed a general view that fair value accounting in distressed markets 

has had a significant impact on the recent financial crisis due to downward pressure created as 

investors are encouraged to sell sooner than they would otherwise which further depresses prices 

in illiquid or distressed markets. One commenter351 observed that the pro-cyclical effect 

resulting from the need to measure such assets based on the current market price, even though 

the market for such asset was inactive or distressed, causes short term market fluctuations for 

assets which are held for long-term investment purposes. These commenters expressed a belief 

that the resulting pro-cyclicality impacts the ability of companies to raise capital as investors, 

creditors and customers observe the decline in U.S. GAAP equity which, in turn, affects the 

safety and soundness of financial institutions. 

 

347 See letters from Roundtable and Anonymous. 

348 See letter from ICAEW. 

349 See letter from MBA. 

350 See letters from Roundtable, Etheridge, Varley, Schryer, Cox, Micheletti, C. Lane, Isaac, Highland, ABA, IBAT, 

CBAI, MIBA, Tchingambu, MBA, Bucks County, Viets, PACB, and IBC. 

351 See letter from Roundtable. 
A-3

Another commenter352 stated its belief that there is a fundamental misunderstanding of fair value 

accounting and that the views expressed by some who believe that fair value accounting led to 

certain bank failures stem more from an interest to shift the blame away from those who engaged 

in poor business and investment decision-making which led to the current crisis. Other 

commenters353 observed that fair value accounting reflects the effects of market conditions as 

well as risks associated with assets held, and generally alerts preparers and users of problems in 

the early stages. These commenters believed that significant losses recognized on these 

underperforming assets have very little to do with financial reporting and more to do with the 

need for effective stewardship. Rather than focusing on the effects of fair value, there is a 

greater need to look objectively and analytically at the root causes of the crisis as opposed to the 

accounting standard that revealed it. Concern over the use of fair value as a measurement basis 

is largely due to the impact on capital adequacy. As such, rather than suspend fair value, one 

focus could be on providing more flexibility in capital adequacy requirements in distressed 

markets. 

One commenter354 thought it would be helpful to ask the following fundamental question when 

evaluating the impact of fair value accounting: “Does FAS 157 Fair Value Measurements 

significantly contribute to the problem or instead, does it reveal an economic condition earlier 

than other systems, thereby aiding in averting a more serious crisis?” 

One commenter355 noted that in some of the recent failures, events leading to the failure were so 

rapid that fair value accounting reflected through quarterly financial reporting could not have 

played a significant role. 

One commenter356 expressed a view that while fair value accounting is not the cause of the 

current financial crisis, it certainly exacerbated the crisis. However, two commenters357 noted 

that they believe that suspension of fair value accounting would cause further confusion and 

distress in the markets resulting from a lack of confidence among investors. 

One commenter358 submitted a copy of a white paper prepared by Stephen G. Ryan, Professor of 

Accounting and Peat Marwick Faculty Fellow, Stern School of Business, New York University 

and highlighted the following three conclusions from that study: 

• There is no “convincing empirical evidence” that fair value accounting contributed to the 

current global economic crisis and that the crisis is primarily the result of bad operating, 

investing, and financing decisions, poor risk management, and in some instances fraud. 

 

352 See letter from ITAC. 

353 See letters from ITAC, Credit Suisse, ICAEW, CFA, NASBA, Evans, PwC, Benson, Gichini, ICGN, Markit, 

CAQ, and Landsman. 

354 See letter from NASBA. 

355 See letter from ICAEW. 

356 See letter from Anonymous. 

357See letter from Anonymous and A. Hamilton. 

358 See letter from CII. 
A-4

• Fair value accounting for financial instruments provides investors with more informative 

reporting, particularly during a global economic crisis, than other alternative accounting 

approaches. 

• Fair value accounting for financial instruments, coupled with disclosure, reduces uncertainty 

about values reported in the financial statements and therefore mitigates the duration of a 

global economic crisis. 

IV. Impact of Fair Value Accounting on the Quality of Financial Information Available 

to Investors 

Several commenters359 indicated that the current application of SFAS No. 157 in distressed 

markets leads to less relevant and reliable financial information due to the uncertainty of market 

pricing embedded in the fair value measurements reflected in the financial information 

disseminated among investors. One commenter360 suggested the use of management’s best 

estimate of economic value of the asset in the basic financial statements with supplemental 

disclosure of the assets’ market price. 

One commenter361 observed that the application of fair value accounting effectively results in 

liquidation values which may be more appropriate for investment funds or entities with 

significant liquidity or going concern issues. As such, this commenter stated that while such a 

measurement basis has a place in financial reporting, standard-setters should consider other 

alternatives for measuring performance based upon a longer term investment value. 

One commenter362 noted that in the UK there is a strong view among investors that fair value 

accounting for financial instruments provides useful information and significantly increases the 

transparency in financial reporting. However, this commenter also notes that many financial 

instruments are not required to be measured at fair value and does not support a requirement for 

all financial instruments to be measured at fair value. 

Several commenters363 observed that fair value accounting provides insight to investors, 

creditors, and all other potential financial users in gathering information to make investment 

decisions since it provides an accurate assessment of the current market value. These 

commenters stated that investors are given additional insight into the risks to which the company 

may be exposed and the potential liquidity issues the company could face if it needed to sell 

securities rather than hold them for the long-term. 

 

359 See letters from ABA, Roundtable, and Tchingambu. 

360 See letter from Roundtable. 

361 See letter from MBA. 

362 See letter from ICAEW. 

363 See letters from Gueye, CAQ, and Landsman. 
A-5

One commenter364 observed that in order to achieve the maximum level of transparency and 

comparability, the concept of fair value accounting needs to be applied consistently across all 

institutions and products, and encourages joint work at the Boards on creating a consistent set of 

global standards. 

V. Process used by the Financial Accounting Standards Board in Developing 

Accounting Standards 

As a general observation related to the accounting standard process, several commenters365

conveyed their continued support and emphasized the importance of the role of an independent 

accounting standard-setter to ensure the needs of investors are served and that any political 

intervention would not impede that standard-setter’s ability to promulgate and issue standards for 

financial reporting. One of these commenters366 further expressed support over the FASB’s role 

as the independent standard-setter and that the FASB continues to operate effectively, in 

cooperation with the SEC, in the interest of investors and other users of financial information. 

This commenter also provided an observation regarding the FASB’s recent expedited due 

process in the issuance of FASB Staff Position FAS 157-3, in consultation with the SEC, in 

which it considered there to be an immediate need for additional guidance on fair value 

measurements. 

A. Development and Implementation of Accounting Standards 

Two commenters367 suggested that the SEC adopt the recommendations made this past summer 

by CIFiR368 to reform the accounting standard-setting development and governance processes to 

test the real world implications of standards before they are implemented, as well as their 

effectiveness post-implementation. One commenter369 also called for an emergency review of 

fair value accounting standards and questioned whether some of the unintended consequences 

arising from the implementation of SFAS No. 157 could have been avoided if a comprehensive 

system was in place for accounting standard development and implementation, including an 

early warning system to allow for swift development of corrective measures to be taken before 

real adverse economic conditions impact the financial markets. This commenter noted that, in 

light of the current crisis in the financial markets, the standard-setting process should also 

involve consultation with the appropriate financial regulators to determine how the development 

of accounting standards may impact other rules and regulations, such as capital adequacy 

requirements. This commenter370 also expressed the need for the PCAOB to issue guidance for 

 

364 See letter from Markit. 

365 See letters from ITAC, Joint Letter, Credit Suisse, FAF, PwC, AICPA, CII, Markit, MBA, CFA, CAQ, 

Landsman, and ICI. 

366 See letter from FAF. 

367 See letters from CCMC and CAQ. 

368 See CIFiR Final Report. 

369 See letter from CCMC. 

370 See Ibid. 
A-6

auditors in evaluating and auditing fair value measurements, including evaluations of fair value 

in markets that are no longer active. 

Another commenter371 cited the recommendations by CIFiR in its Final Report specifically 

related to recognizing the need to improve the accounting standard-setting process, as well as to 

increase investor representation on the FASB and the FAF. 

One commenter372 provided recommendations for the FASB to enhance the standard-setting 

process, including: (1) refrain from accelerated projects which stem from a reaction to a crisis, 

(2) implement pre and post testing of accounting standards, (3) allow for sufficient transition and 

extended exposure periods for the standard, (4) provide a more robust analysis of the comment 

letters considered and reasons why comments were rejected between the exposure draft and the 

final standard, and (5) conduct more study where standards are expected to result in significant 

changes to practice. 

One commenter373 believed that the standard-setters do not appreciate the difficulties 

encountered by small public or private entities when issuing standards. This commenter 

observed that the needs of a select group of users drive the standard-setting process, particularly 

as it relates to fair value accounting, and that a cost-benefit analysis should consider the impact 

on companies of all sizes, public or private. 

One commenter374 suggested that accounting principles affecting the financial system be 

approved by both the Federal Reserve and the FDIC and that the United States not cede authority 

of accounting standard-setting to the IASB. 

B. Standard-Setting Process in Relation to Fair Value Accounting Standards 

One commenter375 observed how fair value has evolved in accounting noting that, prior to the 

issuance of SFAS No. 157, fair value was applied in varying degrees as that measurement basis 

is required on a standard by standard basis. This commenter noted the importance of 

standardizing the definition of fair value, but that in doing so the FASB did not properly consider 

whether that definition still provided the appropriate measurement basis in all instances in U.S. 

GAAP. For instance, in the case of investments trading in inactive markets, this commenter did 

not believe that fair value under an exit value concept is the most appropriate basis. Further, this 

commenter stated that the current basic financial statements do not provide a framework for 

investors to properly understand the impact of fair value and to separate the effect of realized 

versus unrealized changes in fair value in income. As such, this commenter supported 

suspension of all new fair value requirements until the FASB determines the appropriateness of 

fair value as a measurement basis and until the FASB completes its ongoing financial statement 

presentation project. 

 

371 See letter from ICGN. 

372 See letter from MBA. 

373 See letter from Steward. 

374 See letter from Isaac. 

375 See letter from Roundtable. 
A-7

One commenter376 observed the need for the Boards to complete their joint conceptual 

framework project to address the mixed measurement basis used in current financial reporting. 

Another commenter377 recommended that any new standard requiring fair value, as well as the 

application of SFAS No. 157 to non-financial assets and liabilities (which was previously 

deferred by the FASB under FSP FAS 157-2, Effective Date of FASB Statement No. 157), be 

suspended until completion of the congressional review of the fair value study mandated by 

EESA. Another commenter378 expressed the need for such a suspension to allow for additional 

consideration of implementation issues identified by the Valuation Resource Group. 

The most immediate concern, expressed by one of the commenters,379 is the application of fair 

value for business combinations under SFAS No. 141R, which is effective for business 

combinations occurring on or after the first annual reporting period beginning on or after 

December 15, 2008. The commenter noted recent comments expressed during the SEC 

Roundtable on fair value accounting on October 29, 2008 regarding the undesirable impact of 

accounting for mergers under the guidance in SFAS No. 157 and SFAS No. 141R. The 

commenter expressed numerous implementation concerns over the application of SFAS No. 

157’s definition of fair value to acquired loans as well as changes in the way acquired loans are 

recognized in a business combination. They believe that the use of fair value in SFAS No. 141R 

results in inconsistency in the treatment of loans on an institution’s books, which creates systems 

problems for tracking the various accounting methods and will result in difficulty when 

measuring or understanding credit risk for both regulators and management. 

One commenter,380 while supportive of the independent standard-setting process, expressed 

concern over the adequacy of due process surrounding the FASB’s issuance of FSP FAS 157-3. 

This commenter believed that too little time was given to collect and consider feedback as well 

as to investigate potential unintended consequences of that guidance. 

One commenter381 expressed a need for the FASB to evaluate how the results of the SEC’s study 

on fair value accounting should be considered or applied to privately-held entities. 

 

376 See letter from Ramin. 

377 See letter from ABA. 

378 See letter from LeGuyader. 

379 See letter from ABA. 

380 See letter from Markit. 

381 See letter from AICPA. 
A-8

VI. Alternatives to Fair Value Accounting Standards 

A. Enhanced Disclosures of Fair Value Measurements 

Several commenters382 acknowledged the need for improved disclosures surrounding the 

application of fair value accounting in the absence of liquid markets. One commenter383

recommended the creation of a sub-category within the fair value hierarchy for illiquid or 

dysfunctional market conditions. In such situations, financial instruments that meet certain 

criteria would continue to follow the appropriate balance sheet and income statement 

classifications with enhanced disclosures. The criteria would center on whether the market 

for such asset is dislocated or inactive and the entity has the ability and intent to hold the 

asset to maturity or recovery. However, a refined valuation methodology would be based 

upon the financial instrument’s expected future cash flows discounted at the instrument’s 

original effective interest rate which would result in a departure from the exit value concept 

currently in SFAS No. 157. This measurement would be coupled with qualitative 

disclosures such as why the market is dislocated or inactive, and a discussion of the effect 

of selling such securities in the market, including selling the security at a market price 

significantly below the carrying value of the security. This commenter believed the 

proposed approach will provide investors with valuations that consider both the market’s 

short-term pricing vagaries and the fundamental risk to the entity in holding these financial 

instruments for a longer period of time. Additionally, this commenter stated that the 

proposed solution will continue to support the underlying intent of SFAS No. 157, which is 

to provide transparency in a company’s accounting valuation process and consequently, 

emphasize the importance of disclosures in a company’s financial statements. 

Certain commenters384 recommended that the measurement basis of fair value be removed from 

the basic financial statements and that such a measurement basis should be communicated 

through robust footnote disclosures in order for investors to continue to receive critical 

information about current asset values while avoiding the suboptimal steps required of issuers to 

meet capital requirements during times of market distress. Another commenter385 suggested that 

such disclosure should be optional based on the particular needs of investors. 

B. Financial Statement Presentation of Fair Value Measurements 

Two commenters386 supported the use of fair value accounting as a measurement basis in 

financial reporting but did not support the use of that measurement basis in the reporting of 

current periodic income or loss. Rather, these commenters supported the use of fair value as a 

measurement basis in a separate financial statement which would provide useful information to 

investors and users to evaluate liquidity and solvency of the entity. 

 

382 See the letters from Roundtable, ITAC, Joint Letter, Credit Suisse, Evans, Waller, Hodge, C. Lane, Eagle, 

Steward, and BAI. 

383 See letter from Roundtable. 

384 See letters from Waller, Hodge, C. Lane, and Eagle. 

385 See letter from Steward. 

386 See letters from Ryan and IPS. 
A-9

One commenter387 recommended that the FASB consider separating the components of changes 

in fair value into (1) incurred credit losses and (2) all other changes in fair value (including, for 

example, liquidity discounts). In addition, this commenter stated that the guidance for reporting 

financial asset impairments could be converged by recognizing the incurred credit loss 

component in income and all other changes as part of OCI until the asset is sold or matures. This 

commenter believed that improvements to the current presentation requirements should be 

considered by modifying the income statement format to allow for visibility into the effects of 

fair value and inclusion of OCI on the face of the income statement. Other commenters388

provided support for this model which they believed puts the issue into perspective and removes 

the “noise” over the difficulty in applying fair value in the current dislocated market 

environment. Further, these commenters noted that such a modification would also align U.S. 

GAAP closer to IFRS. 

C. Fair Value Measurements When Markets are Not Active 

1. Guidance on Determining When a Market is No Longer Active 

Several commenters389 observed that there may be instances where a market is disrupted to the 

point that the concept of a “willing buyer-willing seller” no longer operates and that, in such 

circumstances where the bid-ask spreads widen, the market might be considered inactive leading 

to the use of alternative measures of fair value. Further, a number of commenters390 believed 

that additional guidance should be developed to assist preparers in determining when a market is 

no longer “active” as well as how to value assets in disorderly or inactive markets. 

One commenter391 observed that a distinction should be made between illiquid and distressed 

assets, or correspondingly between “volume illiquidity” and “funding illiquidity.” When 

measuring Level 3 assets, this commenter submits that it would be appropriate to include a 

volume liquidity premium when measuring the fair value of such assets. However, this 

commenter stated that funding illiquidity is driven by certain participants’ need for immediate 

capital and therefore is not an appropriate attribute of fair value. This commenter believed that 

there is a need for further education on the appropriate factors to consider when measuring Level 

3 assets. 

2. Application Concerns over the Issuance of FSP FAS 157-3 

One commenter392 expressed operational concerns over the FASB’s recent clarification in FSP 

FAS 157-3 noting the onerous and costly exercise for preparers to be able to produce a strong 

 

387 See letter from PwC. 

388 See letters from Central, SunCorp, CAQ, and BAI. 

389 See letters from Towers, ABA, Credit Suisse, and C. Lane. 

390 See letters from Towers, Credit Suisse, LeGuyader, Urban, Houlihan, CAQ, and Nationwide. 

391 See letter from Houlihan. 

392 See letter from Steinmetz. 
A-10

enough alternative analysis of fair value on a security-by-security basis to overcome the apparent 

market price obtained by reference to quotations in illiquid or inactive markets. 

Several commenters393 expressed a view that application of the exit price notion in SFAS No. 

157 to financial instruments in inactive or illiquid markets results in an unrealistic downward 

bias that reduces transparency. These commenters noted that recent FSP FAS 157-3, allows for 

the use of judgment and allows for a more realistic use of observable and unobservable data 

rather than relying on forced liquidation sales as a measure of fair value. However, these 

commenters noted that the guidance also provides that expected cash flows include appropriate 

risk-adjusted discount rates to reflect credit and liquidity risk. These commenters observe that 

incorporating a severe liquidity risk assumption in the current market is representative of a 

distressed sale which is inconsistent with the objective in SFAS No. 157. Therefore, these 

commenters expressed a view that the guidance is circular. These commenters generally support 

expanded disclosure to provide investors with information on current exit prices. One of the 

commenters394 also noted that the guidance is too complicated and is not practical for both large 

and small banks to apply based on the volume of assets that would need to be evaluated. One 

commenter395 noted that rather than apply a liquidity risk premium inherent in the market, an 

appropriate liquidity risk premium should factor in the planned holding period of the security. 

 

Another commenter396 stated that the guidance in FSP FAS 157-3 puts excessive reliance on the 

importance of internal assumptions and that the guidance does not take into account the wealth 

of other observable data points that may be available and relevant. This commenter supported 

the current work of the IASB’s Expert Advisory Panel and summarized some of the statements 

by that panel on how to determine an accurate estimate of fair value in the current environment 

as follows: 

• For a financial product that is not actively traded the user should take into account all sources 

of data. 

• The user cannot ignore a transaction that has taken place. While he might decide not to use 

it, is should be included as part of this judgment process. 

• “For some products consensus pricing data might be the best source of pricing information.” 

• “Forced transactions” that could potentially be ignored are rare. The simple fact that a 

product trades at a very low price, or prices are determined in a marketplace with more 

sellers than buyers, does not imply that the transaction was forced. It is worth noting that, 

even in today’s markets, most trades do take place in orderly transactions at prices that are 

agreed by a willing buyer and a willing seller. 

 

393 See letters from ABA, WesCorp, ACCU, Central, ACLI, Southwest, MBA, and Straka. 

394 See letter from ABA. 

395See letter from Straka. 

396 See letter from Markit. 
A-11

• Judgment is required in deciding whether to use a certain source of data, or to assign a higher 

weight to one source compared to others. 

One commenter397 observed that the objective of fair value is to reflect the price that would be 

received in an orderly transaction for the asset at the time of measurement. However, the 

commenter noted that the current application of this objective has resulted in inappropriate 

application of using “fire sale” prices to determine fair value. This commenter did not believe 

that the guidance provided by the FSP FAS 157-3 adds clarity. The commenter believed that 

there needs to be education to ensure there is a consistent understanding and application of fair 

value among financial statement preparers, auditing firms, analysts, examiners, and market 

participants. 

One commenter398 expressed the need for specific audit guidance from the PCAOB related to 

OTTI and fair value, in general, to allow for a more consistent approach when auditing fair value 

measurements and assessing OTTI. 

3. Use of Fair Value as a Measurement Basis When Markets are Not 

Active 

One commenter399 observed that the exit price objective of fair value is just as important to 

investors when markets are illiquid as in other times. This commenter expressed a belief that 

valuing financial instruments that are required to be measured at fair value using something other 

than an exit price objective would result in inconsistent measurements of fair value and would 

not provide users with the most transparent information. 

Several commenters400 believed, in general, that quoted market prices in inactive or illiquid 

markets do not reflect an accurate assessment of the current value of such assets. These 

commenters were generally comprised of two groups. The first group401 generally believed that 

fair value accounting should be suspended for assets which do not have a readily determinable 

price in active markets. The second group402 believed that alternative valuation methodologies 

should be employed in determining the fair value. In situations where fair value is suspended, 

one commenter403 expressed the need for management to provide more robust disclosure when 

assets are recorded at historical cost where an inactive or illiquid market exists, including the 

range of prices exchanged for such assets in the inactive or illiquid market. Another 

 

397 See letter from ICBA. 

398See letter from FHLBA. 

399 See letter from CAQ. 

400 See letters from UN-L, Miller, Tarasuk, Spicer, Evans, Micheletti, Petersen, Haslem, C. Lane, Carmony, 

Anonymous, and Xylos. 

401 See letters from UN-L, Miller, Evans, C. Lane, Carmony, BNP, and Xylos. 

402 See letters from Tarasuk, Spicer, Haslem, and Anonymous. 

403 See letter from Evans. 
A-12

commenter404 observed that in the current environment some “favored” financial institutions 

have access to federal assistance while others do not and may need to borrow from these favored 

institutions. These favored institutions may influence the fair value inputs faced by the 

disadvantaged financial institutions in a manner that further depresses market prices which are 

already at distressed levels.

One commenter405 supported enhanced disclosures for financial instruments that do not trade in 

active markets and stated that such disclosures should be provided consistent with the guidance 

in Regulation S-K. 

One commenter406 acknowledged that when markets are inactive, fair value measurements are 

less reliable and therefore less useful by comparison with measurements taken from active 

markets. However, this commenter did not believe that reverting to a historical cost accounting 

model for assets in inactive markets would be an improvement. 

Several commenters407 suggested that the FASB issue additional guidance that would allow for 

adjustments to current severe liquidity risk premiums to levels observed during periods of 

normal market activity when measuring fair value for impaired HTM securities as well as AFS 

securities where management has the intent and ability to hold to recovery. Some commenters408

referred to such a value as an intrinsic or economic value. These commenters noted that liquidity 

risk premiums may be appropriate for trading securities as well as AFS securities where 

management does not have the intent or ability to hold to recovery. 

 

One commenter409 stated that additional guidance is needed to clarify that a present value cash 

flow model should be based on expected cash flows adjusted by expected losses. This 

commenter stated that, in practice, discount rates are being applied to cash flows that are not 

adjusted for expected losses if HTM. Further, this commenter suggested that the discount rate 

should incorporate a credit risk premium that factors in any residual credit risk equivalent to the 

cost of capital for that residual credit risk. 

D. Lower-of-Cost-or-Fair-Value 

One commenter410 observed that recent discussion surrounding fair value accounting has ignored 

the positive impact fair value accounting had on the financial institutions in periods leading up to 

the current crisis in the financial markets. Several commenters411 believed that the FASB should 

 

404 See letter from UN-L. 

405 See letter from Xylos. 

406 See letter from ICAEW. 

407 See letters from SunCorp, ACCU, Central, Corporate One, FHLBC, and MBA. 

408 See letters from ABA and FHLBC. 

409 See letters from Straka. 

410 See letter from Fischer. 

411 See letters from Fischer, Sigmon, Vetter, Varley, Viets, Cox, Gorton, Cross, Kleist, and Isaac. 
A-13

move to a more prudent historical cost model. Where adjustments to amortized cost are 

required, one commenter412 suggested an approach based on a present value methodology using 

discounted cash flows and an appropriate historical risk premium, rather than relying on quotes 

from illiquid markets. Other commenters413 believed that subsequent adjustments below the 

carrying amount should only be recognized to the extent such losses are permanent or realized. 

In such cases, these commenters stated that fair value measurement could be useful to investors 

through expanded footnote disclosures of current selling prices.414

One commenter415 suggested that the appropriate measurement basis should depend on whether 

the asset is held for long-term or short-term investment purposes. Under this view, assets held 

for long-term investment purposes should be recognized at amortized cost and subsequently 

evaluated for permanent impairment even where quoted market prices in active markets are 

available. 

One commenter416 expressed a view that fair value should be suspended temporarily for a period 

of 12 to 18 months while the markets recover and U.S. housing prices stabilize. 

One commenter417 noted that fair value is more relevant to investors and financial statement 

users than amortized cost since it reflects the market’s current assessment of the value of the 

underlying asset. This commenter stated that fair value provides more comparable measures of 

value than amortized cost which is a function of the cost at inception or purchase and does not 

incorporate changes in the value over time. 

E. Recognition of Changes in Fair Value over Time 

Some commenters,418 although generally supportive of fair value accounting, recommended a 

principle for delayed recognition of unrealized gain or losses on changes in fair value as opposed 

to immediate recognition. These commenters generally believed that the current financial crisis 

is driven in large part by overvaluations during periods preceding the current crisis which is now 

resulting in a severe undervaluation of assets. One commenter419 supported the development of 

a classification system whereby assets are classified based on risk and an amortization technique 

is applied to each risk category. Under this system, fair value changes for higher risk assets will 

be recognized into income over an accelerated period compared to lower risk assets. 

 

412 See letter from Sigmon. 

413 See letters from Vetter, Varley, Smith, Cox, Gorton, Cross, and Isaac. 

414 See letters from Cross, Isaac, and Nguyen. 

415 See letter from Smith. 

416 See letter from Bucks County. 

417 See letter from ICI. 

418 See letters from Edgtton, Keating, Harmon, and IPS. 

419 See letter from IPS. 
A-14

F. Other Fair Value Measurement Alternatives 

Some commenters420 believed that the current exit price objective in SFAS No. 157 is a flawed 

objective. Certain commenters421 believed that fair value should provide information for what 

the holder believes the asset will be worth at the time of maturity or disposal. One commenter422

suggested that industry-specific guidance for determining fair value measurements in particular 

industries be provided. 

One commenter423 suggested an amendment to the fair value hierarchy in SFAS No. 157 to 

consider both quoted prices in active markets as well as discounted cash flows models, allowing 

for management to give appropriate weight to both methods when assigning fair value. 

 

One commenter424 believes that preparers should be able to develop estimates of fair value based 

on either market, historical, or model-based methods according to their judgment, so long as the 

asset values using other methods are also clearly disclosed in the footnotes to the financial 

statements. This commenter stated that the use of this method would allow for all available 

information to be used when coming up with the most precise estimate and multiple 

combinations would be allowed with weights used and the impact of alternative weightings 

clearly disclosed. 

One commenter425 recommended an approach based on the liquidity of the underlying asset. 

Under this approach, non-liquid assets would be valued based on applying a cash flow, 

replacement cost, and market condition analysis. 

One commenter426 believed that there is a fundamental difference in determining the fair value 

for equity securities and mortgaged-backed securities. This commenter stated that mortgagebacked securities should be valued based on the present value of the expected cash flow streams 

from the underlying mortgage. Under this approach, the lack of liquidity associated with 

conditions in the financial markets can be acknowledged through the classification of the 

security as a long-term asset. 

G. Simplify Guidance on Accounting for All Financial Instruments 

One commenter427 observed the current mixed-attribute framework for measuring various 

financial instruments. This commenter suggested that the measurement basis for financial 

 

420 See letters from Morfesis, Saidens, and O’Malley. 

421 See letters from Morfesis, and O’Malley. 

422 See letter from O’Malley. 

423 See letter from New World. 

424 See letter from Georgetown. 

425 See letter from Rembert. 

426 See letter from King. 

427 See letter from Members United. 
A-15

instruments should be simplified by requiring all financial instruments, except for trading, to be 

measured at amortized cost. Under this approach, financial instruments classified as trading 

would still be measured at fair value with an exit price objective and financial instruments, other 

than trading, that are considered impaired should be measured at their net realizable value rather 

than a liquidation or exit value. This commenter observed that debt securities backed by loans 

should be valued similar to HFI loans. 

 

H. Expansion of Fair Value Measurement Requirements 

One commenter428 believed that the current erosion of capital is driven by the mixed-attribute 

model assigned to assets and liabilities in the financial statements. This commenter suggested 

that fair value should be expanded as the measurement basis for liabilities which, during poor 

economic cycles, will result in a decline in the fair value of liabilities thereby increasing equity 

without the need to raise additional capital. 

One commenter429 suggested that fair value, as a measurement basis in financial reporting, is 

appropriate if applied to all financial instruments rather than segmenting the application to 

certain items on the balance sheet. According to this commenter, the FASB’s issuance of SFAS 

No. 159 attempted to resolve this discrepancy but is only an option and, therefore, adds to the 

lack of comparability between financial institutions. 

One commenter430 expressed concern over expansion of fair value as a measurement basis in 

financial reporting beyond today’s scope until standard-setters, management, and other capital 

market participants reflect, analyze, and debate the use of fair value in financial reporting. This 

commenter stated that standard-setters need to establish a framework for determining when to 

use fair value in financial reporting and modify the presentation of financial statements to 

communicate the impact of fair value measurements and changes in fair value on the business. 

I. Use of Judgment in Fair Value Measurements 

The use of judgment is required when developing an accurate assessment of an asset’s fair 

value. Several commenters431 observed that the use of judgment is required when 

developing an accurate assessment of an asset’s fair value and recommended additional 

guidance from the SEC and / or FASB that elaborates on the use of judgment when 

applying SFAS No. 157 in an inactive market beyond the guidance recently provided in 

FSP FAS 157-3. In addition, one commenter432 recommended that the PCAOB issue 

guidance for auditors that further clarifies that companies can utilize their judgment for 

price assessment in an inactive market. 

 

428 See letter from Hale. 

429 See letter from SunCorp. 

430 See letter from PwC. 

431 See letters from Roundtable, CCMC, Joint II, and Anonymous. 

432 See letter from Roundtable. 
A-16

J. Valuation Oversight Body 

A concern expressed by some commenters433 pointed to the need for greater guidance on how 

valuations should be conducted. One commenter434 observed that SFAS No. 157 Level 3 

valuations carry an inappropriate negative connotation which could be avoided by establishing 

consistent valuation standards to enhance the quality of the valuations. This commenter raised 

the need to established and recognize a professional organization that would develop standards 

of practice and provide oversight over those responsible for valuing “hard-to-value” financial 

instruments using Level 3 mark-to-model approaches.

One commenter435 cited a concern expressed by CIFiR in its Final Report over the inadequate 

infrastructure in the U.S. to support valuations for financial reporting. This commenter 

expressed support for developing and maintaining standards for the reporting and disclosure of 

valuations and the need to develop a framework of guidance on best practices to allow for the 

consistent delivery of those standards. This commenter, while supportive of the content in the 

white paper recently published by the IASB’s Expert Advisory Panel, expressed concern over 

continued development of valuation guidance in isolation from “mainstream” valuation practice 

and that such guidance should be developed following a due process similar to the IASB’s own 

standards. 

K. Improvements to Other-Than-Temporary Impairment Model 

Several commenters noted deficiencies in the current framework under U.S. GAAP for 

evaluating OTTI.436 Under a recommended approach, 437 securities classified as HTM and AFS 

under SFAS No. 115 would continue to be reported as described in that literature (HTM reported 

at amortized cost and AFS reported at fair value). However, under this approach, the OTTI 

model would be primarily focused on credit risk and the change in fair value due to changes in 

credit risk, rather than changes due to other variables such as interest rates. This alternative 

model would recognize OTTI if loss events provide objective evidence of credit impairment. 

Under this model, the impairment recognized would be calculated by comparing the carrying 

amount of the instrument with the present value of estimated future cash flows discounted at the 

financial asset’s original effective interest rate. One commenter438 suggested that the discount 

rate used for measuring impairment should be based on the original yield spread plus the current 

benchmark interest rate. Some commenters439 also suggested that subsequent recovery of fair 

value for previously impaired investments should be recorded as a realized gain or loss, as 

 

433 See letters from Towers and IVSC. 

434 See letter from Towers. 

435 See letter from IVSC. 

436 See letters from Roundtable, ABA, MassMutual, BUSL Students, Citi, CAQ, Nationwide, ACLI, WesCorp, 

ACCU, Corporate One, Southwest, FHLBC, FHLBA, Straka, and BAI. 

437 See letters from Roundtable, ABA, MassMutual, Citi, CAQ, Nationwide, ACLI, Straka, and BAI. 

438 See letter from Straka. 

439 See letters from Roundtable, ABA, Nationwide, FHLBA, and BAI. 
A-17

opposed to the current accretion or amortization model into net investment income. One 

commenter440 provided the following considerations as support for this model: 

• More reflective of the expected cash flows to be generated by the investor; 

• More consistent with the overall accounting models for AFS and HTM debt instruments; 

• Impairment measurement model for loans is well developed and more applicable to many 

debt instruments; 

• Lack of reliable market prices for debt securities; and 

• Reduces complexity by measuring credit impairment for loans, HTM debt instruments and 

AFS instruments. 

Another commenter441 believed that additional guidance should be provided for determining fair 

value in inactive or illiquid market and that more flexibility should be afforded to securities that 

trade in those markets to allow for use of pricing models incorporating market participant data, if 

available, in establishing the fair values. For securities classified as HTM under SFAS No. 115 

which are other-than-temporarily impaired, this commenter suggested that credit losses be 

reflected through income while the other loss components of the fair value measurement be 

suspended temporarily for a period of one to two years.

Some commenters442 noted the disparate models of a mortgage-backed security under SFAS No. 

115 and the underlying loan assets which are accounted for under SFAS No. 114. Specifically, 

some commenters443 noted that SFAS No. 114 requires impairments to be measured based on the 

present value of expected future cash flows discounted at the loan’s effective interest rate. These 

commenters generally support a net realizable value model when measuring OTTI, when an 

entity has the intent and ability to hold until recovery or maturity, noting that securitized loans 

should not be treated differently than un-securitized loans when the intent and ability to hold the 

investments is present in both cases and the underlying collateral is the same. 

 Some commenters444 expressed a need to also harmonize the OTTI models in SFAS No. 115 

and EITF Issue No. 99-20 and recommended an elimination of the “ability and intent to hold to 

recovery” test in SFAS No. 115 and Staff Accounting Bulletin Topic 5M, Accounting for 

Noncurrent Marketable Equity Securities, and replacing it with a requirement to recognize an 

impairment loss (based on fair value) when it becomes probable that an investor will sell an 

otherwise impaired security. Under these proposed changes, OTTI would be recognized only 

when there is credit loss impairment or when it becomes probable that an investor will sell an 

 

440 See letter from Citi. 

441 See letters from BUSL Students. 

442 See letters from WesCorp, ACCU, Corporate One, Southwest, FHLBC, CAQ, FHLBA, and BAI. 

443 See letters from FHLBC, CAQ, FHLBA, and BAI. 

444 See letters from CAQ, ACLI, and BAI. 
A-18

otherwise impaired security. Another commenter445 expressed a view to modify the scope of 

EITF Issue No. 99-20 to apply only to residual interest investments while other debt securities 

would follow SFAS No. 115. 

V. Other Areas of Comment 

Some commenters446 expressed concern over the use of fair value which is based on short-term 

market pricing when determining the value of certain long-term liabilities such as pensions. One 

commenter447 suggested that fair value, as used in SFAS No. 158, Employers’ Accounting for 

Defined Benefit Pension and Other Postretirement Plans, be temporarily suspended until the 

current economic situation stabilizes. In order to continue providing transparency to investors 

and other users, expanded footnote disclosure could reflect the funded status of plans based on a 

fair value measurement of the underlying plan assets. 

One commenter448 recommended changes to the incurred loss model when accounting for HFI 

loans. This commenter believed that loans with credit impairment or loans under default should 

continue to be reported at amortized cost until the point where the bank takes ownership of the 

foreclosed property, at which point the loan should be written down to the fair value of the real 

estate. 

One commenter449 provided an observation that a significant amount of the negative reaction and 

confusion concerning fair value accounting relates to a lack of education on the subject. This 

commenter recommended that the SEC or FASB issue a white paper to describe the model for 

determining fair value under SFAS No. 157, as well as when fair value is used as a measurement 

basis under U.S. GAAP. 

One commenter450 suggested that the SEC obtain formal views from the various U.S. depository 

institution regulators on the topic of fair value to evaluate the need to reconcile the SEC’s 

mandate for investor protection with the mandate that those regulators have to protect the safety 

and soundness of the U.S. financial system. 

One commenter451 provided a study over the application and use of fair value in financial 

reporting. This study highlighted five principles that may be helpful in determining when fair 

value accounting would be applicable. In addition, this study provided an example of different 

financial statement presentation formats to help communicate and distinguish the application of 

fair value accounting and historical transaction accounting. 

 

445 See letter from Nationwide. 

446 See letters from InFRE and Providence. 

447 See letter from Providence. 

448 See letter from Montroy. 

449 See letter from LeGuyader. 

450 See letter from AICPA. 

451 See letter from Columbia. 
A-19

One commenter452 expressed concern over several areas centered around fair value accounting 

and requested that the SEC Staff conduct a review of these areas in its study, including: (1) the 

interaction of OTTI and fair value, (2) how fair value accounting takes into account 

management’s intent to hold the asset until maturity, and (3) practices engaged by auditors in 

auditing fair value measurements. 

One commenter453 expressed concern over the FASB’s current project to improve and simplify 

the financial reporting of hedging activities. This commenter expressed a view that the 

elimination of the bifurcation-by-risk approach as contemplated in this project will act as a 

deterrent to an entity’s ability to manage its interest rate risk and requests that the SEC Staff 

considers this pending change as part of the fair value study. 

One commenter454 suggested that the SEC study include a survey of publicly-held financial 

institutions to specifically identify practice issues that remain in the application of SFAS No. 157 

and the various areas in accounting where fair value is deployed. 

One commenter455 expressed concern over the requirement to value insured credit default swaps 

using a fair value measurement basis. The commenter notes that SFAS No. 133 exempts 

traditional financial guarantee insurance policies written by bond insurers from fair value 

accounting. This commenter pointed out that insured CDS contracts function nearly identical to 

traditional financial guarantee policies and that the form should not drive the different 

accounting treatment. This commenter suggested that SFAS No. 133 be amended to provide a 

scope exception for credit protection in credit derivative form that is written by bond insurers 

subject to Article 69 of the New York Insurance Law. 

 

452 See letter from CUNA. 

453 See letter from FHLBC. 

454 See letter from MBA. 

455 See letter from MBIA. 
A-20

Exhibit A.1: List of Commenters 

Commenter Affiliation Abbreviation Date 

I. Members of Congress - This group includes members of Congress. Bachus, Spencer 

U.S. House of Representatives, Committee on Financial Services 

Bachus Oct 14, 2008 http://sec.gov

II. Preparers - This group includes preparers, preparer-related professional organizations, and advisors to prepareAssociation of Corporate Credit Unions ACCU Oct 28, 2008 http://sec.govBNP Paribas BNP Nov 13, 2008 http://sec.govBridgePointe Advisors BridgePoint Nov 13, 2008 http://sec.govBridgePointe Advisors BridgePoint Nov 13, 2008 http://sec.govCannon Company Cannon Nov 13, 2008 http://sec.govCitigroup Citi Nov 12, 2008 http://sec.govCorporate One Federal Credit Union Corporate One Oct 28, 2008 http://sec.govCredit Suisse Group Credit Suisse Nov 13, 2008 http://sec.govEagle National Bank Eagle Oct 1, 2008 http://sec.govFederal Home Loan Bank of Atlanta FHLBA Nov 26, 2008 http://sec.govFederal Home Loan Bank of Chicago FHLBC Nov 12, 2008 http://sec.govFirst Federal of Bucks County Bucks County Nov 10, 2008 http://sec.govHighland Capital Management, LP Highland Oct 23, 2008 http://sec.govHoulihan Lokey Houlihan Nov 11, 2008 http://sec.govIntegrated Planning Strategies, LLC IPS Oct 30, 2008 http://sec.govMassachusetts Mutual Life Insurance Company MassMutual Nov 13, 2008 http://sec.govMBIA, Inc. MBIA Nov 13, 2008 http://sec.gov
A-21

Commenter Affiliation Abbreviation Date 

Members United Corporate Federal Credit Union Members United Oct 17, 2008 http://sec.govNationwide Insurance Group Nationwide Nov 13, 2008 http://sec.govProvidence Health & Services Providence Nov 10, 2008 http://sec.govSleeping Bear Partners Sleeping Bear Oct 1, 2008 http://sec.govSouthwest Corporate Federal Credit Union Southwest Oct 24, 2008 http://sec.govSquare 1 Bank Square 1 Oct 8, 2008 http://sec.govSunCorp Corporate Credit Union SunCorp Oct 27, 2008 http://sec.govSunCorp Corporate Credit Union SunCorp Nov 12, 2008 http://sec.govU.S. Central Central Oct 27, 2008 http://sec.govU.S. Central Central Nov 13, 2008 http://sec.govWestern Corporate Federal Credit Union WesCorp Oct 24, 2008 http://sec.govWestern Reserve Capital Management Western Jul 25, 2008 http://sec.govWestern Reserve Capital Management Western Sep 25, 2008 http://sec.govXylos Corporation Xylos Dec 5, 2008 http://sec.govIII. Auditors - This group includes auditors. PricewatherhouseCoopers LLP PwC Oct 29, 2008 http://sec.govPricewatherhouseCoopers LLP PwC Oct 1, 2008 http://sec.govIV. Standard-Setters - This group includes standard-setters and related formal and informal advisory groups. Financial Accounting Foundation FAF Oct 2, 2008 http://sec.govFinancial Accounting Foundation FAF Oct 27, 2008 http://sec.govInternational Valuation Standards Committee IVSC Nov 13, 2008 http://sec.govV. Academics - This group includes academics. Angel, James J. 

Georgetown University, McDonough School of 

Georgetown Nov 12, 2008 http://sec.gov
A-22

Commenter Affiliation Abbreviation Date 

Business 

Columbia Business School Columbia Oct 31, 2008 http://sec.govGorton, Donald Wayne State University Gorton Oct 28, 2008 http://sec.govLandsman, Wayne R. 

KPMG Professor of Accounting, KenanFlagler Business School, University of North Carolina 

Landsman Nov 21, 2008 http://sec.gov

Ryan, John University of Wollongong Ryan Oct 28, 2008 http://sec.govSmith, David and Webinger, Mariah University of Nebraska UN-L Nov 13, 2008 http://sec.govWaller, William Ph.D. University of Arizona Waller Oct 23, 2008 http://sec.govWilson, Peter G. Boston College Wilson Oct 29, 2008 http://sec.govVI. Consultants - This group includes consulting firms engaged in, among other things, the use of fair value in finanBankLogic.Net, CPA's & Consultants BankLogic Nov 3, 2008 http://sec.govMarkit Group Limited Markit Nov 12, 2008 http://sec.govNew World Actuaries New World Nov 13, 2008 http://sec.govPartnership Consultants, Inc. Partnership Consultants Oct 23, 2008 http://sec.govTowers Perrin Towers Nov 13, 2008 http://sec.govVII. Professional Organizations - This group includes accounting and finance professional organizations with broainformal professional groups. American Bankers Association ABA Nov 13, 2008 http://sec.govAmerican Bankers Association ABA Sep 23, 2008 http://sec.govAmerican Bankers Association ABA Oct 13, 2008 http://sec.govAmerican Council of Life Insurers ACLI Oct 30, 2008 http://sec.govAmerican Council of Life Insurers ACLI Nov 13, 2008 http://sec.gov
A-23

Commenter Affiliation Abbreviation Date 

American Institute of Certified Public Accountants AICPA Nov 11, 2008 http://sec.govAppraisal Institute and American Society of Farm Managers and Rural Appraisers 

 AI/ASFMRA Nov 7, 2008 http://sec.gov

BAI CFO Roundtable BAI Dec 3, 2008 http://sec.govCenter for Audit Quality CAQ Nov 13, 2008 http://sec.govCenter for Audit Quality, CFA Institute, Consumer Federation of America, Council of Institutional Investors, and Investment Management Association 

 Joint Nov 14, 2008 http://sec.gov

Center for Audit Quality, CFA Institute, Consumer Federation of America, and Council of Institutional Investors 

 Joint Oct 15, 2008 http://sec.gov

Center for Capital Markets Competitiveness CCMC Nov 13, 2008 http://sec.govCenter for Capital Markets Competitiveness CCMC Sep 26, 2008 http://sec.govCenter for Capital Markets Competitiveness CCMC Oct 14, 2008 http://sec.govCommercial Mortgage Securities Association CMSA Oct 22, 2008 http://sec.govCommunity Bankers Association of Illinois CBAI Oct 8, 2008 http://sec.govCredit Union National Association CUNA Nov 13, 2008 http://sec.govFinancial Services Roundtable Roundtable Nov 13, 2008 http://sec.govIndependent Bankers Association of Texas IBAT Oct 8, 2008 http://sec.govIndependent Bankers of Colorado IBC Oct 16, 2008 http://sec.govIndependent Community Bankers of America ICBA Nov 13, 2008 http://sec.gov
A-24

Commenter Affiliation Abbreviation Date 

InFRE Retirement Resource Center InFRE Nov 10, 2008 http://sec.govInstitute of Chartered Accountants in England and Wales ICAEW Nov 13, 2008 http://sec.govInternational Corporate Governance Network ICGN Nov 13, 2008 http://sec.govInvestment Adviser Association IAA Nov 13, 2008 http://sec.govInvestment Company Institute ICI Nov 14, 2008 http://sec.govMissouri Independent Bankers Association MIBA Oct 8, 2008 http://sec.govMortgage Bankers Association MBA Nov 13, 2008 http://sec.govNational Association of State Boards of Accountancy NASBA Oct 27, 2008 http://sec.govPennsylvania Association of Community Bankers PACB Oct 16, 2008 http://sec.govU.S. Chamber of Commerce, Financial Services Roundtable, Property Casualty Insurers Association of America, American Council of Life Insurers, Mortgage Bankers Association, and American Insurance Association 

 Joint II Oct 23, 2008 http://sec.gov

VIII. Investor and Other Users - This group includes individual investors and other users, investor groups, investoattorneys representing users. American Investor American Investor Oct 9, 2008 http://sec.govAnderson, Arthur T. A. Anderson Nov 4, 2008 http://sec.govAnderson, David V. D. Anderson Oct 20, 2008 http://sec.govAnonymous Citizen Anonymous Nov 12, 2008 http://sec.govAnonymous Citizen Anonymous II Dec 10, 2008 http://sec.govArmstrong, Ronald Armstrong Sep 30, 2008 http://sec.govBaldwin, Timothy L. Emile Banks Associates Baldwin Oct 8, 2008 http://sec.gov
A-25

Commenter Affiliation Abbreviation Date 

Benson, Robert Benson Nov 12, 2008 http://sec.govBjork, Ruth A Bjork Nov 11, 2008 http://sec.govBlack, John G. Black Oct 28, 2008 http://sec.govBoone, Irene Boone Oct 20, 2008 http://sec.govBucalo, MaryAnn Bucalo Nov 7, 2008 http://sec.govCarl Carl Oct 22, 2008 http://sec.govCarmony, John Carmony Oct 9, 2008 http://sec.gov

93.htm 

CFA Institute CFA Oct 1, 2008 http://sec.govCFA Institute CFA Nov 11, 2008 http://sec.govCouncil of Institutional Investors CII Oct 29, 2008 http://sec.govCouncil of Institutional Investors CII Sep 25, 2008 http://sec.govCox, David The Bradbury Co., Inc. Cox Oct 28, 2008 http://sec.govCross, Jeffery Cross Oct 6, 2008 http://sec.govDavis, Kurt E. The Davis Law Firm Davis Sep 29, 2008 http://sec.govDuPont, James M. DuPont Nov 2, 2008 http://sec.govEdgtton, Jason Edgtton Oct 28, 2008 http://sec.govEtheridge, Chris Etheridge Oct 22, 2008 http://sec.govEvans, Onex P. Evans Oct 28, 2008 http://sec.govEvans, Scott TIAA- CREF Evans Oct 29, 2008 http://sec.govFastiggi, Jason Scoggin Capital Management Fastiggi Oct 29, 2008 http://sec.govFischer, Urs P. Fischer Nov 6, 2008 http://sec.govFoster, Marc VP Investments, UBS Foster Oct 25, 2008 http://sec.govGichini, Brittany Gichini Nov 12, 2008 http://sec.govGrossman, Steve Grossman Aug 7, 2008 http://sec.govGueye, Khadid Gueye Nov 12, 2008 http://sec.govHale, Jon Partnership Consultants, Inc. Hale Oct 20, 2008 http://sec.govHaley, Jay Haley Dec 1, 2008 http://sec.govHamilton, Alexandra A. Hamilton Dec 2, 2008 http://sec.govHamilton, Stephen W. Hamilton Nov 7, 2008 http://sec.govHarmon, David Harmon Sep 29, 2008 http://sec.govHaslem, Mark Haslem Oct 11, 2008 http://sec.gov
A-26

Commenter Affiliation Abbreviation Date 

Hazen, Steven Hazen Nov 12, 2008 http://sec.govHodge, David Gimbal Capital Management Hodge Oct 9, 2008 http://sec.govInvestors Technical Advisory Committee ITAC Nov 13, 2008 http://sec.govIsaac, William M. Secura Group of LECG Isaac Oct 29, 2008 http://sec.govJeremiah, Roger W. Jeremiah Oct 30, 2008 http://sec.govKeating, Patrick Keating Sep 30, 2008 http://sec.govKent, David W. 

Member of Association of Cost Engineers International 

Kent Oct 11, 2008 http://sec.gov

King, William King Oct 13, 2008 http://sec.govKnorr, Thomas L. Knorr Oct 9, 2008 http://sec.govLane, Chris C. Lane Oct 9, 2008 http://sec.govLane, Fred F. Lane Nov 9, 2008 http://sec.govLeavitt, Barbara Leavitt Oct 20, 2008 http://sec.govLeGuyader, Louis LeGuyader Oct 9, 2008 http://sec.govLeGuyader, Louis LeGuyader Sep 28, 2008 http://sec.govLevin, Douglas K. Levin Hu, LLP Levin Nov 17, 2008 http://sec.govLofgreen, Shad Lofgreen Nov 21, 2008 http://sec.govMassey, Zara Massey Oct 25, 2008 http://sec.govMcAllister, Teresa T. McAllister Nov 10, 2008 http://sec.govMcAllister, Willis C. W. McAllister Oct 9, 2008 http://sec.govMicheletti, Art Micheletti Oct 15, 2008 http://sec.govMiller, Jeffrey A. Miller Oct 28, 2008 http://sec.govMontroy, Vernon Montroy Oct 24, 2008 http://sec.govMorfesis, Alex G. Trusted Capital Solutions, LLC Morfesis Oct 28, 2008 http://sec.govMurray, Lewis Murray Oct 14, 2008 http://sec.govNguyen, Dan J. Nguyen Nov 23, 2008 http://sec.govOh, Lottie Oh Oct 23, 2008 http://sec.govOlson, Sue Olson Oct 10, 2008 http://sec.govO’Malley, Niall H. Blue Point Investment Management, LLC O'Malley Dec 12, 2008 http://sec.gov
A-27

Commenter Affiliation Abbreviation Date 

Owen, Daryle Owen Oct 15, 2008 http://sec.govPetersen, John L. Fefer Petersen Cie. Petersen Oct 17, 2008 http://sec.govPhillips, James E. Phillips Oct 18, 2008 http://sec.govPierce, Steven Pierce Sep 30, 2008 http://sec.govPigg, Gary L. Pigg Oct 20, 2008 http://sec.govPiper, Jason B. Piper Oct 9, 2008 http://sec.govPoweski, Mark Poweski Sep 30, 2008 http://sec.govQuigley, Peter Renvyle Partners, LLC Quigley Nov 19, 2008 http://sec.govRamin, Kurt Paul Ramin Nov 12, 2008 http://sec.govRaz, Sharon, Gutierrez, Isabel, Huesler, Lukas, and Dias, Roy BUSL Students Nov 13, 2008 http://sec.govRembert, Donald M. Rembert Pendleton Jackson Rembert Nov 25, 2008 http://sec.govRisgaard, David North Star Asset Management Risgaard Dec 8, 2008 http://sec.govRogers, Vincent Mtax Rodgers Dec 4, 2008 http://sec.govSaidens, Susan M. Saidens Oct 22, 2008 http://sec.govSchneider, Mark Schneider Dec 8, 2008 http://sec.govSchryer, Tom Schryer Oct 31, 2008 http://sec.govSchuler, Marcus Markit Schuler Oct 20, 2008 http://sec.govSconyers, Richard Sconyers Dec 2, 2008 http://sec.govSigmon, Michael Sigmon Oct 22, 2008 http://sec.govSmith, Gregory H. 

Domino Foods, Inc., American Sugar Holdings, Inc. 

Smith Nov 1, 2008 http://sec.gov

Smith, Stephen T. Conectiv Energy S. Smith Nov 11, 2008 http://sec.govSpicer, Dave Spicer Nov 4, 2008 http://sec.govSteinbacher, Gunther Steinbacher Oct 20, 2008 http://sec.govSteinmetz, Charles T. Elliott Company Steinmetz Nov 5, 2008 http://sec.govSteward, Dan Steward Oct 24, 2008 http://sec.govStraka, Patrick J. CIB Marine Bancshares, Inc. Straka Dec 3, 2008 http://sec.govStrandt, W. Strandt Oct 21, 2008 http://sec.govTarasuk, Brian H. Tarasuk Oct 30, 2008 http://sec.gov
A-28

Commenter Affiliation Abbreviation Date 

Tchingambu, Delphine Tchingambu Nov 12, 2008 http://sec.govUrban, Walter Urban Nov 13, 2008 http://sec.govVarley, Philip The Barrington Group, Inc. Varley Oct 30, 2008 http://sec.govVetter, James Vetter Oct 21, 2008 http://sec.govViets, Gilbert F. Viets Nov 5, 2008 http://sec.govViets, Gilbert F. Viets Nov 23, 2008 http://sec.govViets, Gilbert F. Viets Dec 15, 2008 http://sec.govvon Kleist, Karsten Kleist Oct 16, 2008 http://sec.govWalker, Ray Walker Sep 30, 2008 http://sec.govYounger, Nancy Younger Oct 2, 2008 http://sec.govIX. Securities Information Processors - This constituency includes organizations that provide quotation services for Pink OTC Markets Inc. Pink OTC Dec 10, 2008 http://sec.gov
B-1

Appendix B - Participants in SEC Roundtables on Fair Value 

Accounting 

 I. July 9, 2008 

Panel One – Larger Financial 

Institutions 

Jane B. Adams 

Managing Director 

Maverick Capital 

Russell B. Mallett, III 

Partner – National Professional Practice 

PricewaterhouseCoopers LLP 

Kathy Petroni 

Professor of Accounting 

Michigan State University 

Joe L. Price 

Chief Financial Officer 

Bank of America Corporation 

Kurt N. Schacht 

Managing Director 

CFA Institute Centre for Financial 

Market Integrity 

Matthew L. Schroeder 

Managing Director 

Goldman Sachs 

James S. Tisch 

President and CEO 

Loews Corporation 

Panel Two – Other Public Companies 

 

Leonard W. Cotton 

Vice Chairman 

Centerline Capital Group 

Sam Gutterman 

American Academy of Actuaries 

Charles Holm 

Chief Accountant 

Federal Reserve Board’s Division of 

Banking Supervision and Regulation 

Gary R. Kabureck 

Corporate Vice President, Chief 

Accounting Officer 

Xerox Corporation 

Kenneth B. Robins 

President and Treasurer 

Fidelity Investments — Equity and High 

Income Funds 

R. Harold Schroeder 

Director of Relative Value Arbitrage 

Carlson Capital 

Wes Williams 

Executive — Assurance Professional 

Practice 

Crowe Chizek and Company LLC 

John B. Wojcik 

Executive Vice President and Chief 

Financial Officer 

Bank of the West 
B-2

II. October 29, 2008 

Panel One – Mark-to-Market 

Accounting for Financial Institutions 

Ray Ball 

University of Chicago 

Vincent Colman 

PricewaterhouseCoopers LLP 

Scott Evans 

TIAA-CREF 

William Isaac 

Former Chairman, FDIC 

Richard Murray 

SwissRe 

Aubrey Patterson 

Bancorp South 

Damon Silvers 

AFL-CIO 

Panel Two – Potential Improvements 

to the Current Accounting Model 

Randy Ferrell 

Fauquier Bankshares, Inc. 

Patrick Finnegan 

CFA Institute 

Bradley Hunkler 

Western Southern Life 

Lisa Lindsley 

CtW Investment Group 

Cindy Ma 

Houlihan Lokey Howard & Zukin 

Chuck Maimbourg 

Key Bank 

Richard Ramsden 

Goldman Sachs 

Russell Wieman 

Grant Thornton LLP 

III. November 21, 2008 

James Gilleran Jay Hanson 

Former Director, OTS McGladrey & Pullen, LLP 

Richard Jones Wayne Landsman 

Dechert LLP University of North Carolina 

David Larsen Dane Mott 

Duff and Phelps LLC JP Morgan Chase 

Donald Nicolaisen Samuel Ranzilla 

Former Chief Accountant of the SEC KPMG LLP 
B-3

David Runkle Kevin Spataro 

Trilogy Global Advisors The Allstate Corporation 

Mark Thresher Bob Traficanti 

Nationwide Financial Citigroup
B-4
C-1

Appendix C - Illustration of Revised Financial Statement 

Presentation to Segregate Amounts by Measurement Attributes, as 

Proposed by CIFiR456

The following comments explain the items in the illustration above: 

• Column A – Cash received ($2.7 million) by the company represents the majority of 

sales recorded in the income statement this period. 

• Column B – Cash spent to purchase equipment (i.e., $500,000 of capital expenditures) is 

recorded as an asset under U.S. GAAP; it is not treated as an immediate expense, and 

therefore does not affect current income. 

• Column C – Accounting accruals reflect routine bookkeeping entries. For instance, sales 

made on credit ($75,000) near the end of the period represent revenue in the income 

statement, even though they will not be collected until a later date. Depreciation 

expense ($9,000) is recorded to allocate part of a previously-acquired asset’s original 

cost to the current period. Lastly, the company reduced earnings by 100% of the interest 

expense it incurred under a lending arrangement this period ($225,000). Note it only 

paid a portion of its obligation in cash ($125,000), leaving the remainder to be paid at a 

later date. 

 

456 CIFiR Final Report, at pages 32-34. 

A BC D E F

Cash Flow 

Statement

Cash flows 

Not 

Affecting 

Income

Accounting 

Accruals 

Other Than 

Remeasurem

ents

Recurring Fair 

Value Changes

Remeasureme

nts Other 

Than 

Recurring Fair 

Value 

Changes

Income Statement 

(A+B+C+D+E)

Operating

Cash received from sales 2,700,000 75,000 2,775,000 Sales

0 (1,000,000) (1,000,000) Loss on trading securities

0 (9,000) (9,000) Depreciation expense

0 (15,000) (15,000) Impairment expense

Investing

Capital expenditures (500,000) 500,000 0

Financing

Interest paid (125,000) (100,000) (225,000) Interest expense

. .

. .

. . Net Cash Flows XXX YYY Net Income

Reconciliation of the Statements of Income and Cash Flows

Non-cash items affecting income
C-2

• Column D – Recurring fair value changes describe items measured at fair value every 

period (quarterly and annually). In this case, the company recorded a loss ($1 million) 

on its actively-traded investment securities due to a market downturn. U.S. GAAP 

requires adjusting these securities to fair value each period even if they are not sold. 

• Column E – Remeasurements other than recurring fair value changes identify adjustments 

recorded only after a triggering event happens or when management decides that a decrease 

in value is other-than-temporary. For example, due to unforeseen events, the company 

recorded a goodwill impairment charge ($15,000). 
D-1

Appendix D - FASB and FAF Members (2008) 

I. FASB Members (As of December 2008)457

The five members of the FASB serve full time and are required to sever all connections with the 

firms or institutions they served prior to joining the Board. While collectively they represent 

diverse backgrounds, they also must possess knowledge of accounting, finance, and business, 

and a concern for the public interest in matters of financial accounting and reporting. 

FASB members are appointed for five-year terms and are eligible for reappointment to one 

additional five-year term. Expiration dates of current terms are indicated. 

Robert H. 

Herz, 

Chairman 

2012 

Robert H. Herz was appointed chairman of the FASB, effective July 1, 2002, and was 

reappointed to a second term effective July 1, 2007. Previously, he was a senior 

partner with PricewaterhouseCoopers. 

Prior to joining the FASB, Mr. Herz was PricewaterhouseCoopers North America 

Theater Leader of Professional, Technical, Risk & Quality and a member of the 

firm’s Global and U.S. Boards. He also served as a part-time member of the 

International Accounting Standards Board. Mr. Herz is both a certified public 

accountant and a chartered accountant. 

 

Thomas J. 

Linsmeier 

FASB 

Member 

2011 

Thomas J. Linsmeier was appointed as a member of the FASB in July 2006. An 

award-winning teacher and researcher with particular expertise in financial reporting 

for derivatives and risk management activities, Dr. Linsmeier was formerly Russell 

E. Palmer Endowed Professor and Chairperson of the Department of Accounting 

and Information Systems at Michigan State University. 

Dr. Linsmeier has served as chairman of the Financial Accounting Standards 

Committee and president of the Financial Accounting and Reporting section of the 

American Accounting Association. He is a member of the American Institute of 

Certified Public Accountants and received his Ph.D. and M.B.A. from the University 

of Wisconsin–Madison and his B.B.A. from the University of Wisconsin–

Milwaukee. 

Leslie F. 

Seidman 

FASB 

Member 

2011 

Leslie F. Seidman was appointed to the FASB, effective July 1, 2003.458 Prior to 

joining the Board, Ms. Seidman managed her own firm, providing consulting 

services to major corporations, accounting firms, and other concerns. Previously, 

Ms. Seidman was vice president of accounting policy at J.P. Morgan & Company 

where she was responsible for establishing accounting policies for new financial 

products and analyzing and implementing new accounting standards. Ms. Seidman 

started her career as an auditor in the New York office of Arthur Young & Company 

(now Ernst & Young LLP) and is a certified public accountant. 

 

457 See http://www.fasb.org/facts/bd_members.shtml. 

458 Leslie Seidman was initially named to a three-year term to complete the term of John K. Wulff, who resigned 

from the FASB effective June 30, 2003. See “Leslie F. Seidman Named to FASB; Gary S. Schieneman 

Reappointed to Board,” FASB Press Release (April 29, 2003). (available at: 

http://www.fasb.org/news/nr042903.shtml) Leslie Seidman was reappointed to a five-year term effective July 1, 

2006. See “Leslie F. Seidman Reappointed to Financial Accounting Standards Board, FASB Press Release (March 

6, 2006). (available at: http://www.fasb.org/news/nr030606.shtml) 
D-2

Prior to launching her consulting practice, Ms. Seidman served the FASB in various 

capacities, most recently as assistant director of implementation and practice issues, 

but also as industry fellow and project manager. 

Marc A. 

Siegel, 

FASB 

Member 

2013 

Marc A. Siegel was appointed to the FASB effective October 20, 2008, which term 

extends until June 30, 2013. Prior to his appointment, Mr. Siegel led the Accounting 

Research and Analysis team at the RiskMetrics Group in Rockville, Maryland. 

Mr. Siegel was appointed to the FASB Investor Technical Advisory Committee 

(ITAC) in January 2007 and is a frequent guest on CNBC and other financial TV 

programs, often speaking on various accounting issues in the news. He graduated 

Magna Cum Laude from the Wharton School of Business with a B.S. in economics 

in 1991. 

Lawrence W. 

Smith, 

FASB 

Member 

2012 

Lawrence W. Smith was appointed to the FASB for a five-year term beginning on 

July 1, 2007. As part of the five-member FASB he is responsible for advancing the 

Board’s mission to establish and improve financial accounting and reporting 

standards to increase transparency for users of financial reports and increasing 

investor confidence in the capital markets. 

Prior to his appointment, Mr. Smith spent five years as FASB Director–Technical 

Application and Implementation Activities. In this role, he managed FASB activities 

related to application and implementation issues and served as chairman of its 

Emerging Issues Task Force (EITF). 

Mr. Smith joined the FASB staff in 2002 after a distinguished 25-year career at 

KPMG. He was a partner with KPMG from 1988 to 2002, headquartered most 

recently at its Stamford, Connecticut office. From 1992 to 1996 he served as a 

partner in the firm’s Department of Professional Practice in New York. 

Mr. Smith earned his Master of Science degree in accounting from Northeastern 

University. 

 
D-3

II. FAF (As of December 2008)459

Officers 

Robert E. Denham, Chairman 

Robert T. Blakely, Vice Chairman 

Teresa S. Polley, President and Chief Operating Officer 

Douglas R. Ellsworth, Vice President, Secretary, & Treasurer 

Ronald P. Guerrette, Vice President 

Board of Trustees 

W. Steve Albrecht 

Associate Dean and Professor 

Marriott School of Management 

Brigham Young University 

John J. Perrell 

Retired Vice President—Global Policies 

American Express Company 

Rick Anderson 

Chairman 

Moss Adams LLP 

Susan M. Phillips 

Dean - The George Washington University School 

of Business

Frank H. Brod 

Corporate Vice President Finance and 

Administration & CAO 

Microsoft 

Lee N. Price 

President and Chief Executive Officer 

Price Performance Measurement Systems, Inc. 

Ellyn L. Brown 

Principal 

Brown & Associates 

James H. Quigley 

Chief Executive Officer 

Deloitte & Touche Tohmatsu 

Timothy P. Flynn 

Chairman and Chief Executive Officer 

KPMG LLP 

John J. Radford 

Oregon State Controller 

State Controller Division 

Edward M. Harrington 

General Manager 

San Francisco Public Utilities Commission 

Paul C. Wirth 

Global Controller 

Morgan Stanley

Duncan M. McFarland 

Former Chairman and Chief Executive Officer 

Wellington Management Company 

 

459 See http://www.fasb.org/faf/faf_officers&trustees.shtml.