Picking A Number When Marking-to-Market

The SEC is reminding financial services firms that they don't have to use fire sale prices when evaluating hard to price assets (see Reuters article). In making the clarification, the SEC reaffirmed that management's internal assumptions can be used to measure fair value when relevant market evidence is not available, and that "distressed or forced liquidation sales are not orderly transactions." Now, instead of relying on fire sale prices, companies can go back to marking-to-model, even when the inputs to models that are based on observable factors are no longer being observed. The greater use of assumptions for valuation has caused a former SEC accountant to state that the SEC directive could be titled "pick a number, any number" in how it gives banks too much leeway in choosing numbers for valuation. Other opponents also feel such steps just reduced the transparency of the real risk facing institutions. While the move may in fact make the real risks less transparent, I am not sure the existing method as used, at least in the current environment where problem assets are nearly impossible to price, is helping the situation. I suspect that at least in the short-term investors are not going to be underestimating the risks that financial institutions are facing just because mark-to-market rules are a little less transparent. At least the new interpretation, and possible additional changes being considered in Congress and elsewhere, should help with liquidity problems while other steps are being taken to help open up and stabilize the credit markets.