Readings: Paulson (1)

"The FASB should begin by looking at the prevailing “historical cost” accounting model, which is hopelessly antiquated for companies principally engaged in the business of financial services or for companies that have become as heavily involved in financial instruments as Enron was.

Instead of requiring such companies to record the current, fair market value of all financial assets and liabilities in their financial statements, historical cost accounting allows them to record certain financial assets and liabilities at their historic cost. Of course, the value of financial instruments varies greatly with the fluctuations of the market. Unless companies account for those fluctuations, their financial statements can conceal tremendous losses.

In today’s world, a corporation’s creditworthiness can deteriorate rapidly—witness Enron, where some of the nation’s largest banks were forced to fulfill billion-dollar commitments just weeks before it collapsed. Yet banks are not required to recognize the fair market value of loan commitments or outstanding loans in their financial statements, even when there has been a major erosion of economic value. Consequently, the economic cost of these outstanding liabilities is unknown to investors, regulators, or the media.

I say this with the recognition that a transition to a system of fair value accounting is not without its difficulties. I also recognize that such a transition will take time. These considerations should not, however, paralyze efforts to move toward accounting practices that will best approximate economic reality."

Hank Paulson, Speech to the National Press Club, June 5, 2002