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FASB 157 was a publication issued by the Financial Accounting Standards Board (FASB) in 2006 to clarify accounting practices for asset valuation at publicly traded companies in the United States. This publication was designed to create more accuracy when it came to statements about asset valuation, providing investors with an idea of the true fair value of assets listed in public disclosures. One immediate result of FASB 157 was significant writedowns at a number of major companies. Changes in accounting practices are dictated by the FASB in response to changing trends in the accounting and finance community.
According to FASB 157, when a company values assets, it must divide them into three different categories on the basis of how reliable their fair value estimates are. Level one assets can be valued with mark-to-market accounting and have the most accurate value estimates because they are pegged to identical assets priced on the open market. Bonds, for example, are easy to value because their fair market value is known.
Level two assets are somewhat trickier to value, and must be valued using a pricing model. This is known as mark-to-model accounting. No equivalent assets are sold on the open market, providing a price point, but assets similar enough to make valuation possible are traded or sold, allowing companies to make a reasonable estimate of the value. Finally, level three assets like mortgage-backed securities cannot be accurately valued and are highly illiquid in nature in most cases.
Companies with a lot of value in level three assets were forced to write down their total value after FASB 157, reflecting the uncertainty of their stated asset valuation. Since a number of companies had invested heavily in the 2000s in precisely these kinds of assets, the effective date of FASB 157 marked a dramatic shift in the value of the stated assets of many companies. This could be used as evidence to suggest the publication was needed, to provide investors with a more accurate picture of the value of the companies they were interested in.
Shortly after FASB 157 took effect in 2007, a global financial crisis occurred, and much of it swirled around level three assets. A number of factors contributed to this crisis, and tightening accounting standards certainly cannot be blamed for the fall in value at many major companies; the change in accounting practices didn't cause a material change in value, but only made the real value of many publicly traded companies more apparent.