The Economist recently ran a piece titled “Messenger, shot” calling for standard-setters to defend accounting rules that are under attack and for politicians and banks to back off.
To set the scene--bankers are apologizing all over the place in public, but behind the scenes they are blaming accounting rules for their problems. There is a fierce lobbying effort going on with bankers and their associations/lobbyists/political backers attacking accounting standard-setters.
The banks moan that accounting rules have forced them to report gigantic losses that are not justified. The banks complain that the rules force them to value some assets at the price a third party would pay (the markets), not the price managers and regulators would like them attain.
Recently the banks’ lobbying has affected accounting standard setting in both the U.S. and internationally. How much impact does this have on the capital markets? Independence of accounting standard-setting is essential to the proper functioning of capital markets. It is being compromised.
In April, Congress beat up the chair of the U.S. Financial Accounting Standards Board (FASB), with the result that they rushed through rule changes giving banks more freedom to use models to value illiquid assets and more flexibility in recognizing losses on long-term assets in their income statements.
European ministers moved in lock step with the U.S. and demanded that the International Accounting Standards Board (IASB) make identical changes. Shortly thereafter, they announced word-for-word changes as in the U.S.
Quotes from the article:
“It was banks that were on the wrong planet, with accounts that vastly overvalued assets. Today they argue that market prices overstate losses, because they largely reflect the temporary illiquidity of markets, not the likely extent of bad debts. The truth will not be known for years. But banks’ shares trade below their book value, suggesting that investors are skeptical. And dead markets partly reflect the paralysis of banks which will not sell assets for fear of booking losses, yet are reluctant to buy all those supposed bargains.”
“To get the system working again, losses must be recognized and dealt with. Japan’s procrastination prolonged its crisis. America’s new plan to buy up toxic assets will not work unless banks mark assets to levels which buyers find attractive. Successful markets require independent and even combative standard-setters. The FASB and IASB have been exactly that, cleaning up rules on stock options and pensions, for example, against hostility from special interests. But by appeasing critics now they are inviting pressure to make more concessions. “
“Standard-setters should defuse the argument by making clear that their job is not to regulate banks but to force them to reveal information. The banks, their capital-adequacy regulators and politicians seem to dream of a single, grown-up version of the truth, which enhances financial stability. Investors and accountants, however, think all valuations are subjective, doubt managers’ motives and judge that market prices are the least-bad option. They are right. A bank’s solvency is a matter of judgment for its regulators and for investors, not whatever a piece of paper signed by its auditors says it is. Accounts can inform that decision, but not make it.”
“Banks’ regulators have to take responsibility. If they want to remove the mechanical link between drops in market prices and capital shortfalls at banks, they should take the accounts that standard-setters create for investors and adjust them when they calculate capital. They already do this to some degree. But the banks’ campaign to change the rules is making inevitable a split between two sets of accounts, one for regulators and another for investors. The FASB and IASB can help regulators to create whatever balance-sheet they want. But in doing so they must not compromise their duty to investors.”