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WASHINGTON: An obscure accounting rule is getting
fresh attention in the current financial crisis, with critics saying
banks are hurt by being forced to recognize losses quickly instead
of holding assets until they recover.
The irony is that the new
accounting standards, which went into effect in November, were in
response to scandals at Enron and WorldCom and aimed at providing
more transparency in corporate finances.
The rules require banks to
recognize the “fair value” of their assets and book losses
immediately instead of allowing them to wait for a recovery—in
some cases pricing the troubled mortgage assets as worthless.
The rule called FAS 157 is an
update of the so-called “mark-to-market” standard requiring
accounting for assets at fair-market prices.
Critics argue it has had the
perverse effect of weakening financial firms, forcing them to raise
capital to offset the anticipated losses—which can put them into a
death spiral if cash is scarce.
”Right now mark-to-market
creates a vicious circle vortex that drags securities prices into
the abyss and threatens the viability of the financial system
itself,” said Robert Brusca at FAO Economics.
”There was no commandment
saying ‘Mark thy securities to the prices prevailing in markets or
suffer the wrath of God.’”
Edward Yingling, president of the
American Bankers Association, said in a letter to regulators this
week that unrealistic accounting standards were a “key factor”
in the financial crisis.
Yingling said in a letter to the
Securities and Exchange Commission that with financial markets
frozen in some areas “there is not a true ‘fair value’” that
can be assigned to troubled assets.
Brian Wesbury at First Trust
Portfolios said Merrill Lynch’s woes underscore the problems. The
Wall Street investment bank was forced to sell $30.6 billion of
illiquid mortgage securities for $6.7 billion, or 22 cents on the
dollar.
”If it did not sell, these
bonds might have fallen to 18 cents and further eroded its capital
on a mark-to-market basis,” Wesbury said. “It couldn’t take
the chance.
”But what if Merrill was
allowed to hold those securities on its books, without marking them
to an illiquid market? The company would not have had to take a
$24-billion loss. And maybe investors in Merrill Lynch would not
have had to settle for a $29-a-share buyout from Bank of America, a
60-percent markdown from the share price less than a year ago.”
John Mauldin, an author and
president of Millennium Wave Advisors, said that if the current
accounting standards had been applied during the Latin American debt
default in the 1980s “every major US bank was bankrupt because
they had loaned Latin American countries far more than their capital
on their books.”
”The current mark-to-market
rule, while nice in theory, works in normal times. But it has the
unintended consequence of making things worse in crisis times,” he
said.
Ed Yardeni of Yardeni Research
said modifying the rule might eliminate the need for the massive
$700-billion government rescue package being debated for the
financial industry.
”I’m not convinced that [the
plan] is even necessary,” Yardeni said.
”I think a simpler solution
would be for the SEC to immediately and temporarily suspend
mark-to-market accounting rules for mortgage-backed assets. Firms
could hold them to maturity [or until the market settles] without
having to take crippling write-downs in the process.”
The accounting industry’s CFA
Institute said however that ending “fair value” reporting
“will only serve to undermine the confidence of investors in our
financial institutions and lead to a further crisis of confidence in
our government.”
Federal Reserve Chairman Ben
Bernanke also cautioned against tinkering with the accounting
standards. “Many banks support this, but doing this would only
hurt investor confidence because nobody knows what the true
hold-to-maturity price is,” he told lawmakers.
Robert Eisenbeis, a former
Federal Reserve official and economist at Cumberland Advisors, said
it was wrong for banks to blame accounting standards.
”The accounting serves as the
canary in the mineshaft, in pointing out where the problems are,”
he said.
Although some bad assets may
rebound in value, he said others do not. “Pretending the losses
didn’t happen doesn’t make it so,” he said.
--AFP
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