Bernanke on Valuation

In a speech that helped drive markets upward today, Federal Reserve Chairman Ben Bernanke talked, in part, about the problem of valuing assets, a problem that to my mind lies at the very heart of the crisis in the financial system. Long story short, he insisted that valuation is a problem because of the competing issues of procyclicality and transparency -- in plain English, between driving the banks deeper into insolvency and telling the truth. Key passage:

The ongoing move by those who set accounting standards toward requirements for improved disclosure and greater transparency is a positive development that deserves full support. However, determining appropriate valuation methods for illiquid or idiosyncratic assets can be very difficult, to put it mildly. Similarly, there is considerable uncertainty regarding the appropriate levels of loan loss reserves over the cycle. As a result, further review of accounting standards governing valuation and loss provisioning would be useful, and might result in modifications to the accounting rules that reduce their procyclical effects without compromising the goals of disclosure and transparency. Indeed, work is underway on these issues through the Financial Stability Forum, and the results of that work may prove useful for U.S. policymakers.

Surely there are better ways to support credit markets than to fudge the numbers on the real health of the banks. Bernanke seems to suggest this, but is short on details. Moreover, markets are not fooled, as reflected in dropping share prices. And regulators surely understand how a lack of transparency precludes effective supervision. If the emporer is naked, we would save ourselves a lot of trouble if we just told him.