Fair value relies on spot price for balance sheet valuations. This is its achilles. Technology stocks, houses (= mbs), metals, oil & natural gas and grains all have parabolic price charts for various intervals over the last 10 years. There are periods of sudden and sharp turns higher, where values increase by 100 and 200%, followed by sudden and sharp turns lower, where values are gutted and go to near zero in the case of mbs’s.

These are not the price patterns of fairly valued assets reflecting physical supply & demand for use over long term periods. It does reflect valuation of the underlying asset as driven by emotional estimates of momentary risk and reward related to trading profit. Can that process fairly value a long lived asset to be held and used in the ordinary course of business for production of goods & services? Or a financial instrument representing the value of a pool of physical assets being used under the same circumstances?

The inertia of insistence that GAAP or IFRS’s fair value is the “better” standard of financial reporting needs to be broken. The credit market’s failure is doing yeoman’s work to that end. With that said, bankers implicating fair value being at the root of their troubles is counterfeit.

Banking abandoned its primary historical objective – shepherding real economic growth by acting as financial stewards of a market based economy. They let go of taking measured investment risk across a variety of core asset classes (consumer and business) within the constraints of deposit based funding. In its place, they binged on transaction fee revenue for the sake of stock price and personal compensation. A strategy that negligently ignored the economic relationship between wage growth and housing prices, to the globe’s detriment.

The collective act tied the nation’s well-being to one counterparty – ARM payments made by borrowers with insufficient income to service their mortgages. When it blew up, the bankers owned primary responsibility. Borrowers & Congressional policy makers split the other half (the risks and flaws they signed on for were apparent from the earliest years).

No matter how ignorant fair value is as a standard in an era of spot markets driven by speculative price movements, financial reporting was not the shovel that dug the hole or threw dirt on the bankers once in the hole. The only real reporting standard that is relative to banks current straits is their regulatory capital calculation.

Historical cost with write-downs for other than temporary impairment is a good standard in the hands of competent management, particularly when fair value is your alternative. The irony is that it and fair value can get you to the same bad answer in the hands of auditors that insist even limited sales of an institution’s assets under duress for strategic reasons establishes the valuation of entire portfolios.

This disregards situations where assets such as mbs’s can and will be held through to a period when their value is again based on the larger percentage of the security that is performing rather than the smaller part that isn’t. In the current hands-off market for mbs’s, they get a worthless valuation, which ignores they are not.

Spot markets are driven by emotion, technical analysis and momentum. Valuation of balance sheets and earnings must be based on long term cash flows of the underlying assets and how they will return over that long term. That is the market the assets will perform in.

Strangling the financials into spot market valuations at periodic reporting dates is very often misleading. And when you look at it, with the demonstrated power of institutional capital to shape and move markets over spot periods, that feels like a large loophole. Owners or shorts can use option and index strategies to move balance sheet values around measurement dates for their own interests.