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Can a switch from fair value save a depleting economy

Can a Switch From Fair Value Save a Depleting Economy?

In this time of economic turmoil and despair Congressmen and financial institution CEOs are trying to figure out a way to dig them out of a recession grave before it is too late. Amidst the 700 billion dollar by out and the collapses of several banks, people are wondering what could have saved us from these dreadful times that we are encountering: maybe a different presidential economic strategy, decreased CEO salaries and bonuses, or more responsible loan and mortgage payments that are American citizens could actually pay off. Maybe all these alternatives are not the problem, maybe we need a switch in the way the books are kept, and maybe it is time move away from Fair Value accounting practices. This article will discuss the good and the bad of Fair Value accounting. It will help inform the readers of why this practice may have caused are economic downturn and the reason behind the government bailout.

Fair Value accounting is the practice of a company marking their assets to current market prices, this is also known as mark to market accounting. During this period of investing inactivity market prices for securities and other assets have declined rapidly this forces financial institutions to write down their assets to these awful market prices. This process raises a problem because it is forcing assets to be valued at lower prices then they should be, which causes the balance sheets of businesses to weaken and losses of millions of dollars to occur. Most financial institutions are going to hold on to these securities till their maturity. During this period of time the market will again become active raising the value of these securities. So this idea raises the question: Why should financial institutions be forced to value their assets at a declining market and lose millions, while in just a few years the market may bounce back raising the market value of the assets? No wonder why financial institutions are calling for a suspension of Fair Value accounting during this recession.

For all the bad Fair Value accounting brings there is also the good side as well. Fair Value accounting helps keep investor confidence high by keeping the valuation of assets of a company consistent with temporary state of the economy. A change from fair value could give top management in a company an excuse to release fictitious values of their assets therefore inflating the balance sheets. After the fraud that led to the collapse of Enron and the loss of so many jobs and shareholders losing everything due to Enron’s incompetence, it is important that investors have reliable information when they invest their money into companies. Fair Value also acted as watchdog over the fledgling economy raising the red flag when the economy started to bust. Without the constant write downs of securities and assets we would have no warning of an economic collapse. So all in all a change from Fair Value accounting to some other form of accounting would favor the management of companies and their bonuses, it would not favor the backbone of the companies which are the investors. Let’s not forget that shareholders of a company are the ones that keep it going so we have to keep investor confidence high to help save the economy from further damage.

Before Fair Value accounting became the appropriate way to value assets and securities, companies used historical cost, but that was eliminated because of the irrelevant values that that method would disclose in corporate financial statements. If fair value accounting is eliminated what are possible alternatives to value assets in the future then? A practice that is commonly brought into the picture is the cash flows that an asset of security will bring to a company that owns it. This component of valuing an asset or security is completely ignored by fair value accounting practices. This seems to be the most effective alternative to fair value accounting, because every asset or security bring in a certain amount cash inflow to a company, how much of this inflow can ultimately determine the value at the present time of an asset. For instance, during this time of economic instability the cash inflows of an asset or security will be extremely low, while during an economic upswing these inflows will be extremely high. This process will give the investor full confidence that a company’s financial statements are disclosed with highest extent of honesty there is.

Is a change from fair value accounting really the answer to saving this economy? It may not be whole answer, but it could be a part to the solution. We have to remember that recessions are part of the economic cycle and every person will go through two or three of them before they die. The best thing to do is take care of your money and keep a close eye on your investments. Anything extra that could help us prevent an economic struggle like changing form fair value accounting is just a bonus.

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