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US: Banks Get New Leeway in Valuing Their Assets

by Floyd NorrisNew York Times
April 2nd, 2009

A once-obscure accounting rule that infuriated banks, who blamed it for worsening the financial crisis, was changed Thursday to give banks more discretion in reporting the value of mortgage securities.

The change seems likely to allow banks to report higher profits by assuming that the securities are worth more than anyone is now willing to pay for them. But critics objected that the change could further damage the credibility of financial institutions by enabling them to avoid recognizing losses from bad loans they have made.

Critics also said that since the rules were changed under heavy political pressure, the move compromised the independence of the organization that did it, the Financial Accounting Standards Board.

During the financial crisis, the market prices of many securities, particularly those backed by subprime home mortgages, have plunged to fractions of their original prices. That has forced banks to report hundreds of billions of dollars in losses over the last year, because some of those securities must be reported at market value each three months, with the bank showing a profit or loss based on the change.

Bankers bitterly complained that the current market prices were the result of distressed sales and that they should be allowed to ignore those prices and value the securities instead at their value in a normal market. At first FASB, pronounced FAS-bee, resisted making changes, but that changed within a few days of a Congressional hearing at which legislators from both parties demanded the board act.

“There is a perception that we are yielding to political pressure,” one board member, Lawrence W. Smith, said as he voted for the changes.

“We are an independent standard setter, and it is important that we maintain our independence,” Mr. Smith added. “At the same time, how can we ignore what is going on around us?”

A group headed by two former chairmen of the Securities and Exchange Commission, one who served under President Bill Clinton and one who was appointed by President George W. Bush, said that it feared that politicization of accounting standards would destroy the credibility of the board.

It is not clear how much bank profits will improve as a result of the change; that will depend on how much the banks use their newly approved discretion to set values. Nor is it clear whether investors will put much faith in the new figures.

Early answers to those questions may become available within a few weeks. The board said banks could apply the new rules to their financial statements for the quarter that ended this week.

One major bank, Citigroup, said the new standard would not cause any change in its statements.

It is rare that the application of an accounting rule becomes a political issue, but that happened this year in both the United States and Europe, where the International Accounting Standards Board held an emergency meeting to change its rule after such a move was demanded by the French president.

In the United States, FASB acknowledged the investor criticism of the rules the board proposed after the Congressional hearing and responded on Thursday by voting to require banks to make additional disclosures about the assets in question.

The five-member board approved three changes to the rules, two by unanimous votes and one with two dissents. That disputed change makes it possible for banks to keep some declines in asset values off their income statements.

Robert H. Herz, the board’s chairman and the man who faced the Congressional pressure, said he voted for the changes because he thought the improved disclosures would help investors.

Mr. Smith said he had considered changing his vote as recently as Thursday morning. That would have led to the defeat of one change sought by the banks and perhaps set off a confrontation with Congress. “But,” he said, “I ultimately decided this is an improvement, because we have significantly improved the amount of information” being disclosed.

The American Bankers Association, which pushed legislators to demand the board make changes, praised the board. “Today’s decision should improve information for investors by providing more accurate estimates of market values,” said Edward Yingling, the association’s president.

One change adopted by the board would require banks to disclose the effect of the changed interpretation, although the final wording has not been released and it is not clear how detailed that disclosure will be.

For some other assets, banks must write them down to market value only if they conclude that the decline is “other than temporary.” The measure that drew dissents will allow banks to keep part of such declines off their income statements, although the decline would still show on the institutions’ balance sheets.

One of the dissenters, Thomas J. Linsmeier, argued that accounting rules already allowed the “fiction all banks are well capitalized,” adding that the changes would “make them seem better capitalized.”

The adoption of the rules was widely expected. It came on the same day that the stock market soared, but that rally began in Asia, well before the board met, and seemed to be tied to indications that the world economy might no longer be getting worse, even if recovery was not imminent.

While it was the banks who pressed for the rule, it will affect all financial institutions. But the board said it would make small changes to assure that it did not change accounting in mutual funds, which must mark their assets to market value every day.

Bank regulators already have the power to adjust accounting in computing capital, and some investor groups argued they should do that, rather than give the banks more freedom to value assets at what they think they should be worth, rather than what someone will pay for them.

The board added to the latest rule a statement that the goal of reflecting market value remained the same, but the rules will still allow more judgment by managers, and thus gives them more ability to control the numbers they report.

The vote drew condemnation from an organization called the Investors Working Group, and the two former S.E.C. chairman who lead it — William H. Donaldson, appointed by the second President Bush, and Arthur Levitt Jr., who served in the Clinton administration.

“In order to create high-quality accounting standards, it is critical that the process be independent and free from political pressure,” the group said in a statement. “This will ensure that such standards are neutral and faithfully represent economic reality. To the extent that these new FASB proposals reduce the free flow of transparent and reliable financial information, they undermine investor interests and weaken their ability to make sound investment decisions.”



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