- The Washington Times - Friday, April 3, 2009

Under intense pressure from Congress and financial institutions, a powerful group that oversees U.S. accounting rules voted Thursday to relax a requirement that forced banks to report massive declines in asset values - a practice that deepened the credit crisis and economic downturn.

The decision by the Financial Accounting Standards Board helped to spark a stock market rally that sent the Dow Jones Industrial Average briefly above 8,000 for the first time in two months.

Under previous “mark-to-market” accounting rules, financial institutions had to value their holdings at market rates, a requirement that severely bruised their balance sheets during economic declines. The new rule permits companies to use more of their own judgment in determining the value of assets - leeway that experts hope will help them survive tough times.

Advocates of the new rule say it will help banks to increase their lending by improving their balance sheets.

Others say the rule change will hurt investors because it will reduce the flow of transparent and reliable information.

Some are horrified by the process that led to Thursday’s ruling.

“To put the standard-setter under the boot of hysterical Congress members responding to the passions of their constituents, you are violating the most fundamental tenets of our democracy,” Arthur Levitt, former chairman of the Securities and Exchange Commission, told The Washington Times in a recent interview.

The new ruling will allow banks to value assets at prices they expect to receive in the future, even if those prices are well above what the current market will pay.

That could undermine the plan recently announced by Treasury Secretary Timothy F. Geithner to leverage private and public capital with federal funds or loan guarantees in order to remove as much as $1 trillion in toxic assets from the balance sheets of financial institutions.

“If banks can value assets higher than what the public-private partnerships are willing to pay, then the banks may be reluctant to sell them because they would have to take a loss,” said Robert Willens, an accounting and tax adviser to hedge funds.

Financial firms argue that plunging market prices for many debt securities are often unrelated to the securities’ underlying value. They say the lack of liquidity and the distressed sales to meet regulatory requirements are major reasons why asset values are falling.

If a debt security originally purchased for $100 is generating $90 of cash flow but is also trading at $70, mark-to-market accounting required the bank to re-value the security at $70 and take a $30 hit on its income statement, explained Richard Dietrich, chairman of the Ohio State University accounting department. If the bank believes the $70 market price reflects distressed selling, it will now be able to value the security at $90 and take only a $10 loss, Mr. Dietrich said.

FASB’s change “will not be the panacea banks thought it would be. Investors will conclude the new values are not the true value of assets,” Mr. Willens said. “Their financial statements will lose credibility. It will by a pyrrhic victory.”

If bankers are right, then they will not be required to record losses today that will never occur, said Mr. Dietrich of Ohio State. But if the markets are right and asset prices continue to decline, then banks will take a bigger hit in the future than they would take today under strict mark-to-market accounting.

“When it comes to valuing debt securities, it’s always a judgment call,” he said.

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