“Those who fail to learn from history are doomed to repeat it.” Winston Churchill’s words should serve as a warning to the Financial Accounting Standards Board (“FASB”) regarding the Current Expected Credit Loss accounting standard (“CECL”). If FASB looks to the past, it will appreciate why the implementation of CECL should be paused and substantially rethought.
The CECL raises questions that many admit require further market experience to evaluate. A similar rush by FASB in the face of unanswered concerns resulted in disastrous financial consequences in 2008 when “mark-to-market accounting” was redefined by FASB. Despite warnings from the banking industry, FASB 157 was activated, and things went south almost immediately, causing massive write-downs of loans by bank and non-bank lenders alike. Accounting or paper losses of $500 billion in U.S. banks triggered a global financial crisis that required a decade to work its way through the economy — a lost decade that brought irreparable harm to millions of people.
As global financial markets went into free fall, the U.S. unemployment rate soared to 11% and housing foreclosures skyrocketed. The Dow crashed from 14,100 in October 2007, to 6,507 in March 2009. That was the same month that Congress held hearings and demanded that FASB and the SEC amend how credit losses for securities were recorded — no longer marking them to market. FASB reluctantly agreed, and it is no coincidence that the start of the current and longest bull market in history began at that point.
Will we ever learn from that horrible experience? FASB and the SEC should rigorously evaluate recent history and determine the role that mark-to-market value accounting rules played in the last crisis before planting the seeds of the next one.
Many people, including us, have been critical of the lack of administrative due process in the CECL standard-setting process. No federal agency can escape challenge as FASB is able to do when promulgating principles that become federal law. In response to criticism, FASB Chairman Russell Golden proudly states that FASB reviewed over 3,000 comment letters and had multiple meetings with banks and investors.
Simply reviewing comment letters is not due process when there is no oversight and no way to examine or challenge the results. When the vast majority of comment letters opposing CECL are ignored and no legal challenge is available, that is not transparency. When FASB’s own Investor Advisory Committee splits on support for CECL, a fair process would suggest a time out. A January 2019 survey by Janney, the large investment house, found that 75% of bank investors oppose CECL. We suggest that the procyclical impact of CECL is finally being appreciated for the damage that it can and will do.
The federal banking agencies are finally beginning to waver in their support of CECL, referencing it lately as “the standard they are required to enforce.” This suggests a growing appreciation for the way that CECL would increase procyclicality and make regulators’ job even more challenging. With tepid support, at best, of regulators or investors, it is difficult to understand how even FASB’s version of due process would allow it to implement the standard as is.
CECL needs to be reconsidered in depth. The recent introduction of legislation, which would delay CECL until an economic impact study is performed, is a step forward. We suggest that this study first assess whether there is still a need for CECL, particularly in view of recent changes FASB has made to loan loss accounting – for example, putting billions of dollars of securitized loans onto bank balance sheets and then expanding disclosures of credit quality information in lending portfolios.
Similarly, since the 2008 crisis, earnings management concerns have been alleviated, as evidenced by the current reserve levels in comparison to actual historical loss activity. Remember the brewing crisis over billions in home equity lines coming due between 2015 and 2018 that never appeared?
With all these moving financial pieces and changes, shouldn’t the question of what problem CECL is attempting to fix be reconsidered? Quite plainly, FASB needs to put CECL on hold until everyone has a better idea what its real impact will be. We are just now recovering from the 2008 crisis induced by FASB, and the last thing we need is another one.
FASB recently announced it would delay implementation of CECL for a year for small banks — that’s it, no further consideration and study of impact CECL will have on banks and the communities they serve. It’s clear that Congress must act immediately so we don’t repeat very painful financial history. Moreover, it is past time for Congress to impose oversight and due process requirements on FASB, particularly since this private, secretive group really does create law and with profound impacts on banks and the communities they serve.
• William M. Isaac, former chairman of the FDIC and Fifth Third Bancorp, is a global consultant to financial institutions and governments. Thomas P. Vartanian, former regulator and law firm partner, is executive director and professor of law at the Antonin Scalia Law School, George Mason University.