God has declared us righteous. What is going on when He does this? It is clear that we were once unrighteous and that now were are considered righteous. What is going on in this transition and how does it happen? There are three explanations (that I know of) which try to describe what happens in this declaration.
1. Legal Fiction
The first explanation is that we are not changed. We remain unrighteous forever, but God legally considers us righteous anyway. Legally we are righteous, but in reality we are unrighteous.
This explanation is not generally accepted by anyone, though it is charged against quite a few. Sloppy Penal Substitution language and metaphors can by highly vulnerable to this charge. "When God looks at us, He doesn't see us, He sees Jesus" is an example of sloppy speech; it implies that that we really aren't righteous. In addition to maintaining that we remain unrighteous, this view also hold that God in some way is deceiving Himself--not seeing the sin in us that is plainly there so that He can declare us righteous.
When Evangelicals have the accusation of "Legal Fiction" leveled at us, we usually respond with...
2. Divine Command
When God declares something to be true, it becomes true even if it wasn't true before. His words have the power to change reality. (c.f. the Genesis creation accounts.) Thus, when God declares us righteous, even though we were unrighteous before, His declaration makes us righteous.
While this has become the standard Evangelical response (and in particular, the standard Reformed response), it suffers from several flaws. For the sake of space, I will only point out the worst one: this shifts the Atonement off of the cross and into the courtroom. No longer is the death and resurrection of Jesus what makes us righteous. It is merely the declaration of God that makes us righteous. In this scheme, if we had been righteous just prior to the declaration, the declaration would not have been needed at all. So we are unrighteous immediately prior to the declaration and righteous afterwards. Where does the cross fit in? What does Jesus have to do with any of it? If the divine command is sufficient, then was Jesus unnecessary for gaining righteousness?
The typical response to this challenge is to claim that the cross and resurrection are the basis upon which God makes this declaration of righteousness.
However, this reinforces my point. If the cross and resurrection are the basis, the prerequisite of the declaration that makes us righteous, then it is not itself that which makes us righteous. What makes us righteous is the declaration itself.
That is unacceptable to me. It must be the cross and resurrection which accomplishes this great work of making me righteous, not a declaration. The cross and resurrection don't just pave the way for some greater act of atonement/reconciliation/justification/salvation. The cross and resurrection are the great work of atonement/reconciliation/justification/salvation. This leads us to my position...
3. Recognizing Reality
When God declares us to be righteous, he is legally recognizing that we have already become righteous some time in the (recent) past. This is much more in line with the legal traditions we are familiar with: Birth certificates recognize that a child has been born, it does not itself cause the child to be born. Death certificates recognize that a person has died, but it does not kill the person. Marriage certificates (ones given in conjunction with religious marriages at any rate) recognize that a marriage has taken place, but it does not itself make them married. So it is with God's declaration: He is recognizing that we are already righteous in Christ. The declaration itself does nothing. It simply records that God acknowledges our newfound righteousness.