Under New Accounting Rule, Toxic Assets May Be Revalued
Friday, April 3, 2009
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.
The move by the Financial Accounting Standards Board was made with unusual speed under intense pressure from Congress and the financial industry, which have argued that the old rules exacerbated the financial crisis by forcing banks to overstate expected losses.
But the decision to ease what are known as mark-to-market requirements has raised concerns among some financial experts who warn that it will become harder for banks and investors to agree on what the troubled assets are actually worth and thus discourage their sale. The ability of financial firms to sell assets to investors is considered essential for an economic revival because this could restore the major source of funding for bank lending to consumers and businesses.
The board also has faced a storm of criticism from accounting and investor groups who view yesterday's move as evidence that it lacks the necessary independence and strength to uphold its judgments in the face of pressure. The nonprofit board, whose decisions are enforced by the Securities and Exchange Commission, proposed the changes four days after it was told to do so by angry members of Congress.
"I was very disappointed in the process in that the independent agency buckled to the strong-armed tactics of Congress," said Arthur Levitt, a former SEC chairman. "This is a step toward the kind of opaqueness that created the economic problems that we're enduring today."
A spokesman for FASB, based in Connecticut, said the board was responding appropriately to an extraordinary economic crisis.
"Our decisions rarely please everyone, but we believe that we have helped market participants this week with this action," said the spokesman, Neal McGarity.
The new rules, which will be published next week, broaden an existing exception to the basic accounting principle that an asset is worth the price that a buyer is willing to pay. This valuation system is called marking to market, and the result is described as a fair value. Companies must disclose the fair value assets that they're willing to sell in quarterly reports.
When a market does not exist -- when there are no buyers for a particular kind of asset -- companies can assign values based on other considerations, such as the amount originally paid for the asset, and any income it produces, such as a borrower's payments on a mortgage. The change made yesterday allows companies to assert the same exception by arguing that the market is broken -- that prices offered by investors for some securities do not reflect the real value of those assets.
The change is important because banks are required to set aside money when an asset declines in value, since the drop reflects a projected loss. It is expected that banks will use this exception to argue that the market prices for some assets are too low, and that they should be allowed to set aside less money.
In part, the impact of the change depends on whether the banks' valuations are correct, according to financial analysts. If losses are smaller than the market has projected, banks will have more money in the short term, which could allow them to increase lending and attract investors, while maintaining adequate reserves against losses.
However, 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."
The volume of assets affected by the change will not become clear until companies report first-quarter earnings. Robert Willens, an accounting expert, estimates the change could boost earnings at some banks by as much as 20 percent. However, Citigroup and Bank of America said they expected the change would not impact their financial results.
The board couldn't clarify yesterday whether banks will need to tell investors how much assets would have been worth under the old rules. The proposal must still be hammered into detailed instructions.
The financial industry and Congress have been lobbying FASB for the changes -- with several lawmakers threatening to usurp the board's powers if it didn't act. FASB Chairman Robert Herz faced outraged lawmakers at a March 12 hearing where he pledged quick action.
The board has faced political pressure before. During the savings and loan failures of the 1980s, bank executives came knocking on the SEC and FASB's doors, asking for changes to fair-value accounting. The SEC chairman at the time, Richard Breeden, refused to budge, said former SEC chief accountant, Lynn Turner.
SEC Chairman Mary L. Schapiro "needed to come out and tell Congress to keep their nose out of it," Turner said.
Schapiro wasn't available to comment yesterday. Her spokesman, John Nester, said: "Our principal focus was that the FASB address an issue raised several months ago, that they promptly seek public comment and that they provide guidance to issuers. We respect their independent judgment and will monitor the application of the new guidance."