FASB Proposes Mark-to-Market Accounting Rules
The Financial Accounting Standards Board has proposed new rules under which banks and other lenders would be required to use mark-to-market accounting.
Banks would have to report both the fair value and amortized cost of loans and some other financial assets and liabilities on their balance sheets under the new rules. Changes in fair value would, in most cases, be recognized in other comprehensive income and could cause swings of billions of dollars in the book values for the biggest lenders.
The American Bankers Association released a statement that said the accounting change would present “significant problems, not only for banks, but also the general economy. If implemented, the proposal would greatly undermine the availability of credit by making it difficult to make many long-term loans, the value of which, even if performing perfectly, would likely be reduced on the day a loan is made.”
The rules would take effect for the biggest banks as early as 2013. Smaller banks, with less than $1 billion in assets, would be permitted to wait until 2017. The FASB is seeking comment through September 30, 2010.
This is restrictive and gets it half right. Report the fair value, disclose it and keep it current. But don’t hit the lenders in the O.C.I. This will discourage lending. Period.
Systemic Risk Council Essential
William M. Isaac, former chairman of the Federal Deposit Insurance Corporation (FDIC) during the saving and loan collapse of the 1980s, wrote an open letter to Senator Bob Corker (R-TN) in Forbes.
In the letter, Isaac maintains that, “Mark-to-market accounting senselessly destroyed over $500 billion of capital in our financial system, panicking the markets as banks reported massive paper losses while still producing large cash-basis profits.”
Mr. Isaac then argues that systemic risk oversight of accounting rules issued by the Financial Accounting Standards Board (FASB) and the Security Exchange Commission (SEC) is essential, “…particularly now that the FASB is proposing to extend mark-to-market accounting to nearly the entire balance sheet of banks, including loans. It is clear that the FASB is living in an ivory tower world in which accounting rules are divorced from economic and business reality, and the SEC has failed to provide effective government oversight.”
“If this proposal by FASB moves forward, it will spell the end of banking as we know it and will make it next to impossible for smaller businesses and consumers to obtain medium- and long-term credit,” Isaac cautions.
Isaac wrote the letter in support of Senator Coker’s amendment to the Financial Regulatory Reform Bill calling for, in part, a systemic risk council. He fears that if a systemic risk council is not give the authority to examine accounting pronouncements by the SEC and FASB, “the next crisis will be just around the corner.”
A systemic risk council was included in the Senate version of the financial regulatory reform bill recently passed. Its exact function is still being debated.
In conclusion, Bill Isaac rocks.
Brown Proposes Fair Value Amendment
Filed under: Congress, Fair Value, Fair Value Accounting, FASB, IASB, SEC
Senators Sharrod Brown (D-OH) and Edward Kaufman (D-DE) have offered an amendment to the Restoring American Financial Stability Act of 2010 that would essentially require the Securities and Exchange Commission (SEC), the Financial Accounting Standards Board (FASB) or both to establish a rule that publicly traded companies list all assets and liabilities on the balance sheet and that these be recorded at fair value.
Historically accounting standards have allowed off balance sheet financing via leases and repurchase agreements. It was recently learned that Lehman Brothers used repurchase accounting to remove liabilities from the balance sheet in a maneuver to increase leverage.
The amendment, if adopted and passed, would also present an obstacle to the effort to merge FASB ad IASB standards. The FASB prefers fair value basis, however the International Accounting Standards Board (IASB) is opposed.
The American Institute of Certified Public Accounts, the Center for Audit Quality, the Chartered Financial Analyst Institute, the Council of Institutional Investors, the Investment Company Institute, the Financial Executives International, and the U.S. Chamber of Commerce have objected to the Brown amendment. Their stated position, in part, is:
We believe political influences that dictate one particular outcome for an accounting standard without the benefit of a public due process that considers the views of investors and other stakeholders would have adverse impacts on investor confidence and the quality of financial reporting, which are of critical importance to the successful operation of the U.S. capital markets.
Silicon Economics Sues the FASB
Economics, Inc. (SEI) has filed a lawsuit in a federal district court against the U.S. Financial Accounting Standards Board (FASB), charging it with antitrust violations and willfully attempting to misappropriate patented technology belonging to the company. The suit concerns Silicon Economics’ EarningsPower Accounting™ (EPA) method, a solution designed to address the inadequacies of mark-to-market accounting.
SEI had submitted their EPA method in response to FASB’s request for public comment on the objectives of financial accounting. FASB had subsequently laid ownership claims to the technology, defending it as fair game under the terms disclosed on their website. SEI denies being informed of those rules.
“FASB’s unlawful attempt to appropriate SEI’s intellectual property undermines innovation and competition, and harms the U.S. economy,” said SEI’s Attorney Perry J. Narancic. “SEI will defend its intellectual property vigorously.”
FDIC Exposes Mark-To-Market Gaps
When taking over a failed bank the Federal Deposit Insurance Corporation (FDIC) reveals vital information about the current market value of an institution’s assets.
There is a significant gap between the FDIC estimated values to those calculated by bank management using mark-to-model accounting subsequent to the Financial Accounting Standards Board (FASB) suspension of fair value accounting in April 2009,
Among recent bank failings the FDIC using mark-to-market accounting valued assets between 96-125% lower then bank management using mark-to-model accounting.
There are no reports of alleged fraud or negligence on the part of management in these bank failings.
Maybe this describes two things: 1) Bad/misbehaving management and/or 2) Liquidation value vs. economic value. Nothing to report here.
IASB and FASB at Impasse over Mark-to-Market Accounting
Mark-to-market accounting is proving to be a major sticking point in efforts to converge the world’s two most important accounting systems, Generally Acceptable Accounting Principles (GAAP) and International Financial Reporting Standards (IASB). In September, the “Group of 20” leading industrialized nations pledged to create a single global set of accounting rules by June 2011.
In a joint statement, the International Accounting Standards Board (IASB) and the U.S. Financial Accounting Standards Board (FASB) said that they had failed to reach an agreement on the valuation of financial instruments. They commented that there was “no guarantee” they would be able to resolve their differences and that it “could affect the project timetables.”
The FASB supports a more widespread use of mark to market accounting than the IASB.
One Year Later
It has been just over a year since the Financial Accounting Standards Board (FASB) suspended mark-to-market accounting. Since that time, when the Dow Jones Industrial Average was around 8,000, the market has gained about 35% in value.
No one is attributing the market rise solely to the change in accounting rules, but it can be argued that the change did have a positive influence on the overall state of the economy. Certainty over asset prices and the decreased volatility helped.
The banking sector, for example, was significantly impacted by the old mark-to-market rule. Since last year banks have been posting steadily improving profits. Citigroup recently announced a $4.4B for Q1 2010, their best in two years; JP Morgan Chase posted $3.3B for Q1 2010, up 55% from the prior year; and Bank of America exceeded analyst expectations with a $3.2B gain for Q1 2010.
Additionally it can be argued that the capitalization pressure on banks that was relieved by easing mark-to-market also made credit more readily available —credit that was necessary in every sector of the economy.
Bankers and Congress did pressure the FASB last year to change the rule. And although less onerous, the new mark to model version isn’t a license to mark things at any level the banks find convenient. There must be an economic rational for the marks, and the SEC can remind auditors that it is their job to make sure that is done prudently.
This all seems to be working. Let’s not change it now, or acquiesce to European rules. If it’s not broke…
FASB and IASB Struggle to Meet in the Middle
While banks and politicians have leaned on accounting regulators to incorporate economic stability concerns into their accounting rules, the question of how banks should value financial instruments remains a subject of intense debate.
“Politicians have been saying a major objective of financial reporting is stability — we think it’s transparency,” said International Accounting Standards Board Chairman Sir David Tweedie.
The IASB had proposed to have assets valued at “amortized cost,” while the U.S. Financial Accounting Standards Board suggested that all financial instruments be valued at market levels. Valuing loans at a market rate would be a significant expansion of mark-to-market accounting, which has been vehemently opposed by the banks.
The FASB and IASB have been working over the last few months to reconcile their views.
Transparency is a better goal. Mark your bonds or loans to whatever price you think, then let the market decide whether you are a liar, a cheat or a charlatan. You just have to publicly disclose, quickly.
New FASB Proposals Released
The FASB released two proposed accounting standards on Wednesday, 5/26/2010:
Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities—Financial Instruments (Topic 825) and Derivatives and Hedging (Topic 815)
Comprehensive Income (Topic 220): Statement of Comprehensive Income
The significance of the two proposals are that they would require virtually all financial instruments to be recorded at fair value on institution’s financial statements. This would be a radical change to existing financial reporting for lending and depository institutions and an unpopular one for the affected institutions. FASB recognizes this and the significant implementation issues and currently recommends an adoption date of more than 5 years for smaller institutions. The required adoption date for larger institutions is not yet determined.
Two of the five FASB Board members had some significant differences of opinion on the proposed standard.
The appropriate accounting for financial instruments has long been debated by the FASB and these current proposals are a part of a joint project the FASB originally started in 2005 with the IASB.
The two proposals can be found here:
Comprehensive Income (Topic 220): Statement of Comprehensive Income
Comment letters are due by September 30, 2010.
First United Chairman Blasts FASB
In a recent letter to shareholders filed with the Security and Exchange Commission (SEC), First United Chairman and CEO William B. Grant addressed the company’s “first annual loss in memory” of $12.8 million. 2009 was the bank’s worst showing in 75 years.
Grant recognized expanded lending in hospitality, insurance and other sectors new to the bank’s portfolio as well as ill-advised real estate investments as the primary culprits. He noted that most of the losses came from “trust-preferred securities” in banks and insurance companies that defaulted on or deferred their obligations.
But he also blasted the “controversial accounting guidance” of the Financial Accounting Standings Board (FASB), taking special aim at mark-to-market accounting. He felt its requirement to recognize the hypothetical losses of potential assets provided an unfair “challenge” to First United and other institutions.
If everything was mark-to-market, you really couldn’t run the bank at anything else than a quarter-to-quarter basis. Short-term loans and short-term liabilities are the only way to ‘manage’ mark-to-market.
