May 26, 2010
By ERIC DASH, New York Times
The group that sets corporate accounting standards proposed an overhaul Wednesday of the way lenders record the value of their assets, hoping that more stringent and consistent reporting rules might help avert another financial crisis.
Under the new rules, banks and other lenders would be required to book their loans at their current market value, a method called mark-to-market accounting. Previously, they had more leeway in valuing assets, so long as they expected to hold them for a long period of time. Critics called that approach “mark to make believe.”
Banks already use mark-to-market accounting for stocks and complex mortgage bonds whose value fluctuates through daily trading. The change in the way they treat the value of loans, however, is expected to be greeted with fierce opposition from banks.
Banks claim that the change would force them to take big losses on loans during periods of economic distress. Doing so would mislead investors, they say, because the loans would probably still pay off over time even if they were trading at lower market prices.
Big investment banks, like Goldman Sachs and Morgan Stanley, should not be affected much by the new rules because they have traditionally used mark-to-market accounting. For regional and community banks that make commercial loans — the vast majority of the nation’s 8,000 lenders — the impact could be drastic.
The group proposing the change, the Financial Accounting Standards Board, an independent body that sets United States accounting standards, said the rules would take effect for the biggest banks as early as 2013. Smaller banks, with less than $1 billion in assets, would be permitted to wait until 2017.
The additional time is intended to give smaller lenders a chance to recover from the financial crisis. If the new rules took effect today, they might force the banks to take tens of billions of dollars of losses on their commercial real estate loans that they have not yet recognized.
Even with the delay, financial companies are likely to put up a fight — just as they did when they were forced to treat stock options as an expense early in the decade, and again last spring, in the aftermath of the financial crisis, when they faced political pressure to start using mark-to-market accounting more broadly.
The American Bankers Association released a statement on Wednesday that said the accounting change would present “significant problems, not only for banks, but also the general economy. If implemented, the proposal would greatly undermine the availability of credit by making it difficult to make many long-term loans, the value of which, even if performing perfectly, would likely be reduced on the day a loan is made.”
But officials with the accounting board say the changes would bolster investor confidence by requiring the banks to more quickly recognize their losses.
Investors complained to the group that the old set of rules did not “faithfully represent the underlying economics,” said Robert H. Herz, the chairman of the accounting board. “The financial crisis reinforced the need for better accounting in this area.”
The proposed changes now enter a comment period that will last until the end of September. The board plans to hold a round a hearings on them in the fall. It will then make final revisions, which will take into account a similar set of rules being proposed by the International Accounting Standards Board.
The proposal is the latest in a series of efforts to tighten up banking regulation and improve financial transparency in the wake of the crisis. Congress is weeks away from passing a sweeping overhaul of financial regulation, affecting products as varied as derivatives and debit cards.
Federal regulators, meanwhile, are adopting a more aggressive posture after being criticized sharply by lawmakers for failing to prevent the crisis through enforcement.
The Financial Accounting Standards Board has been attacked by Congress, too. Last March, members of the House Financial Services Committee pressed the group to relax its rules in order to loosen credit and make loans more widely available. When the board did so, critics said it had caved to pressure from politicians and banks, which could suddenly paint a rosier picture of their financial condition.
Accounting board officials see the new rules as a compromise, hoping to ease the transition from old practices to new ones. Assets that a bank plans to trade or sell, like complex mortgage bonds or other securities, will continue to be booked at their current market value. Any increase or decrease in value will directly affect earnings.
Financial institutions, under the new rules, would have to report two types of valuations for loans: their value as set by buyers and sellers in the market, and their so-called fair value, based on the banks’ own assessment.
To mitigate the effect of large swings in market value for loans, the accounting board will allow banks to split the loss on some assets into two categories: one that would affect the bank’s earnings and another that would affect the bank’s book value.
“It’s a smorgasbord of accounting principles,” said Jack T. Ciesielski, an accounting expert who is editor of the trade publication Analyst’s Accounting Observer. “It will messier to read, but if you know what you are doing you can figure it out.”