Rule change intended to ease bank crisis could make it worse

McClatchy NewspapersApril 1, 2009 

WASHINGTON — The little-known Financial Accounting Standards Board is poised to deliver Thursday a change in accounting rules that proponents say will save the banking system — and opponents warn could bring even more ruin to the U.S. economy.

The FASB board is expected to relax the rules on how banks value assets that investors no longer are willing to purchase.

Current rules require banks to list the value of assets on their books at their current market price — a practice called "mark-to-market." The assets, however, at the center of the global financial meltdown — securities backed by bad mortgages — have no market. Investors simply won't touch them.

That's forced banks to lower the reported value of their assets, and quarter after quarter since mid-2007, they've had to write off more and more losses. That forces them to hoard their capital, rather than lend it, to offset their losses. That's how the housing crisis begat the banking crisis, which begat the U.S. economic crisis, which begat the global financial meltdown.

Banks say the mark-to-market accounting rule has worsened the financial crisis by making institutions appear weaker than they really are. The pools of mortgages, they say, should be valued not on what they're worth today, but what they are expected to be worth at maturity.

"Why should all assets be treated as if they're really for sale?" asked Bert Ely, a banking expert who gained wide recognition during the savings and loan crisis of the late 1980s.

During the S&L crisis, government regulators initially eased federal accounting rules for troubled S&Ls, which hid their negative worth and allowed them to make even worse decisions that led to their collapse and an expensive federal rescue.

Could it happen again?

"That concern does come up with this situation," Ely said. "At what point in time do we move from improved accounting to manipulation?"

Although Ely thinks there are risks in the accounting shift, he acknowledges that mark-to-market has amplified both the mortgage finance and banking crises.

Enter FASB. The Norwalk, Conn., private-sector entity adopts common standards that are accepted by regulators such as the Securities and Exchange Commission.

FASB moved with breakneck speed to consider the rule change after its chairman, Robert Herz, was roughed up by lawmakers on March 12 and warned that Congress could impose new rules if he wasn't willing to do so. Democrats, led by Massachusetts Rep. Barney Frank, the chairman of the House Financial Services Committee, insisted on the change.

FASB is expected to relax mark-to-market rules, sometimes called fair-value accounting, to recognize the maturity value of the mortgage securities often referred to as toxic assets.

Supporters think this will provide a tremendous boost to banks and ease the economic crisis.

"I think change in mark-to-market (rules) would make a big difference. If there's a bottom spotted on the economy, then the banking thing goes away. As soon as Wall Street sees a bottom, then you can make accurate forecasts. When you can do that, the banking crisis ends," said James Paulsen, chief investment strategist for Wells Capital Management, a subsidiary of Wells Fargo. "That's equivalent to a huge toxic asset (being lifted) because you bring private investors back in."

Other supporters, such as investment analyst Ed Yardeni, call the change long overdue.

"I fully agree with investors who insist that mark-to-market is necessary for honest accounting. However, it makes no sense to require financial firms to raise capital just because the values of their assets have been temporarily depressed by a financial crisis," Yardeni wrote this week in a research note.

The rule change could allow banks to use one accounting standard for what it reports to the SEC, whose mandate is investor protection, and a more relaxed standard for reporting to banking regulators. That would ease the demand on banks to raise more capital in a distressed environment.

Critics think the change would allow banks to cook their books by hiding their truly bad assets behind longer maturity dates.

"The biggest problem with mark-to-market isn't mark-to-market, it's what part of the balance sheet is mark-to-market and what part is not," said Franklin Raines, the former chief executive of mortgage-finance giant Fannie Mae. If FASB relaxes the rule for distressed bank assets, he said, "You have got a distortion in the balance sheet that nobody can understand."

The changes would allow banks to revise their first quarter 2009 reports to reflect a hold-to-maturity value on assets that no investor will buy now. Some advocates have proposed allowing this change to apply retroactively to the dismal last quarter of 2008, and perhaps even further back.

The change has been debated from the very start of the financial crisis in mid-2007, so action now raises eyebrows.

"It's an awkward time to do it," said David Wyss, chief economist for the credit rating agency Standard & Poor's in New York. He said it gives the appearance of sweeping problems under the rug.

The action could add more uncertainty, warned Gary Stern, the president of the Federal Reserve Bank of Minneapolis.

"I think it would raise as many problems as it answers," he told McClatchy.

Once the rule change is made, bank balance sheets could appear healthier, but Raines and other financial experts doubt the banks would be perceived that way.

"It's kind of hard to fool people at this stage, where everyone is so focused on what the facts are," Raines said. "I think there are a lot of problems with mark-to-market, but I don't think you are going to change people's views of these banks by moving around the accounting, especially if you are moving away from market prices. I think the average person might be fooled by it, but I don't think smart investors will be fooled by it."

The rule change may also affect the Obama administration's ambitious program to have the government, alongside private investors, buy back as much as $1 trillion of toxic assets polluting bank balance sheets.

"Banks have already taken large markdowns, and may now be able to mark up the values of their assets," analyst Yardeni wrote in a March 25 research note. "In other words, their toxic assets won't be so toxic. Their distressed assets won't be so distressed. They won't be under the gun to raise capital, or beg for more of it from the government."

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