Relaxing Bank Accounting Standards—A Big Mistake

“The board that sets U.S. accounting rules voted yesterday to let financial firms report higher values for some troubled assets, a controversial step likely to increase some banks’ reported earnings but also heighten suspicions that the companies are concealing problems.”[1] The vote Thursday by the Financial Accounting Standards Board (FASB) is a very bad development for several reasons.

1. The FASB caved in to very ill advised pressure from Congress to rush through this dilution of accounting standards, thus undermining the independence and professionalism of the Board.

2. While we don’t know the details, because the new ruling has not actually been written yet, a key lesson from Japan’s lost decade and every other major banking crisis of the last century is that denying or hiding bank losses is a big mistake. “This behavior is corrosive: unhealthy banks either don’t lend (hoarding money to shore up reserves) or they make desperate gambles on high-risk loans and investments that could pay off big, but probably won’t pay off at all. In either case, the economy suffers further, and as it does, bank assets themselves continue to deteriorate—creating a highly destructive vicious cycle. To break this cycle, the government must force the banks to acknowledge the scale of their problems.”[2] Thus the FASB’s ruling is a step backward. It will undermine market confidence in banks further and make the resolution of the problem harder and slower.

3. If banks can record higher values for some of their assets (especially mortgages and Mortgage Banks Securities) it is much less likely that they will sell them to other investors under the Treasury’s new toxic asset purchase scheme, because they will then need to value them at the actual (lower) sale price. When assets are actually sold, mark to market accounting will still apply. One arm of government is undercutting the policies of another.

Arthur Levitt, a former chairman of the SEC said, "I was very disappointed in the process in that the independent agency buckled to the strong-armed tactics of Congress, This is a step toward the kind of opaqueness that created the economic problems that we’re enduring today."[3] “If investors believe banks are overpricing assets, "the capital markets will remain closed to major banks and other financial intermediaries for an extended period of time," the CFA Institute, an investor advisory organization, said in an analysis. The group, which opposed the change, said "investors will not be willing to commit capital to firms that hide the economic value of their assets and liabilities."[4]

This is a potentially dangerous mistake.


[1] Binyamin Appelbaum and Zachary A. Goldfarb, "Under New Accounting Rules, Toxic Assets May be Revalued", The Washington Post, April 3, 2009, Page A15.

[2] Simon Johnson, "The Quiet Coup–The Way Out", The Atlantic, May 2009.

[3] Op. cit., Appelbaum and Goldfard.

[4] Ibid.

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About wcoats

Dr. Warren L. Coats specializes in advising central banks on monetary policy, and in the development of their capacity to formulate and implement monetary policy. He is retired from the International Monetary Fund, where, as Assistant Director of the Monetary and Financial Systems Department, he led missions to over twenty countries. Before then, he served as Visiting Economist to the Board of Governors of the Federal Reserve System, and to the World Bank, and was Assistant Prof of Economics at the Univ. of Virginia from 1970-75. Most recently he was Senior Monetary Policy Advisor to the Central Bank of Iraq; an IMF consultant to the central banks of Afghanistan, Kenya and Zimbabwe; and a Deloitte/USAID advisor to the Government of South Sudan. He is currently a member of the Editorial Board of the Cayman Financial Review and until the end of 2013 was a member of the IMF program team for Afghanistan. His most recent book is entitled "One Currency for Bosnia: Creating the Central Bank of Bosnia and Herzegovina."
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