A veteran US private equity executive has called for the end of fair-value accounting, declaring that ‘the rule as written promotes instability in the markets, rather than transparency
A veteran US private equity executive has called for the end of fair-value accounting, declaring that ‘the rule as written promotes instability in the markets, rather than transparency and consistency’.
The fair-value accounting rule is ‘exacerbating all our other problems,’ John K. Castle, chairman and chief executive officer of New York private equity firm Castle Harlan, told participants at a conference of middle-market private equity firms, arguing that the rule ‘should be dumped and replaced with more traditional accounting approaches.’
The fair-value accounting rule requires banks and other financial institutions to mark-to-market their assets each quarter, immediately booking any unrealised losses as a hit to income.
‘That may unfairly undermine the perceived strength of the institution – and that’s a serious matter,’ Castle said. ‘After all, what is the market that these assets must be marked to? In many cases, it isn’t really a market at all.
‘The idea that all of our nation’s assets should be priced based on the level at which a few bearish hedge funds can jam transactions through the market in the last few moments of the trading day is ridiculous.’
Castle said that traditional accounting practices allowed institutions to hold investments at cost and apply reserves only if there was a diminution of credit quality. This, he said, ‘tended to stabilise reported earnings in turbulent times.’
By contrast, fair-value accounting ‘tends to amplify short-term swings, causing financial institutions to overstate reported earnings in good times and exaggerate reported losses at the cycle bottom. The new rules thus tend to destabilise our banks and our financial system.’
Castle added: ‘Accounting principles can have a profound impact on economic and business policy. They need to reflect the broad economic, regulatory, business and other national policy goals and concerns of the national or international economies to which they apply.’
Castle, now 67, founded Castle Harlan in 1987 after more than 20 years at Wall Street investment bank Donaldson, Lufkin and Jenrette, where after joining the firm in 1965 he began doing what are now called private equity transactions.
As chief executive of the firm’s capital group, he was a pioneer in the creation of private equity limited partnerships as investment vehicles for pension funds, institutional investors and affluent individuals. Castle became president and chief executive of DLJ in 1979.
Since its establishment, Castle Harlan has invested in 49 companies with an enterprise value of more than USD9bn, and its funds have produced gross returns of 30 per cent over the past 16 years.
Its current portfolio companies, which employ more than 42,000 people, include United Malt Holdings, which produces malt for the brewing and distilling industries, and Baker & Taylor, a global distributor of books and entertainment products to libraries and retailers. In Australia Castle Harlan and Champ, a joint venture launched in 2000 as Castle Harlan Australian Mezzanine Partners, have more than USD4.5bn in funds under management.
