Accounting rule that bankers hate is set for an overhaul

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With Congress holding a gun to their heads, accounting rulemakers on Thursday will vote on a plan to give banks more leeway in how they value dicey assets.

The controversy over ‘mark-to-market’ accounting rules has been building since the credit crisis deepened last year. The banking industry contends that overly strict rules since November 2007 have required them to write down the value of many mortgage-related securities to unrealistically grim levels -- in turn ravaging their balance sheets.

Congress last month demanded that the Financial Accounting Standards Board ease mark-to-market rules, or the politicians would do it for them.

‘If the regulators and standard setters do not act now to improve the standards, then the Congress will have no other option than to act itself,’ Rep. Paul Kanjorski (D-Pa.) warned FASB Chairman Robert Herz at a hearing on March 12.

FASB quickly came back with its proposal for relief. That’s what the board will take up on Thursday.

Banks now have three ‘buckets’ for assets. A Level One asset is easily valued based on daily quoted prices (as in the case of stocks, for example). A Level Two asset is one that may not have a solid daily market quote, but whose value can be determined by ‘observable inputs.’ A thinly traded municipal bond might be a good example.

Level Three is for hard-to-value assets. This is where banks essentially can get a pass: A Level Three asset is worth whatever a bank says it’s worth, within FASB guidelines.

The rule makers now propose to give banks more latitude in determining a fair value for Level Three assets. If a bank could make a case that the apparent market value of a mortgage bond is unrealistic -- ‘distressed,’ in FASB parlance -- it could write up the value of the bond to a level it deems more realistic, or at least avoid a write-down.

Investor groups that oppose relaxing mark-to-market rules fear banks will engage in fantasy accounting that will obscure the true health of their balance sheets.

No matter -- it looks like the critics of mark-to-market have won this round.

One question raised in recent days is whether easier mark-to-market rules will reduce banks’ incentive to sell toxic assets under the program Treasury Secretary Timothy Geithner detailed last week. That could raise the risk that the program will flop.

Bloomberg News’ David Reilly, who has opined extensively on the mark-to-market debate, has a different take: ‘FASB’s proposal makes it more likely banks will argue that these sales [under the Geithner plan] don’t represent market values they have to use,’ he writes. ‘In that case, banks may be able to use the Treasury program to cherry-pick values they like while disregarding those that would cause balance-sheet pain.’

Reilly believes bank investors should be horrified by the potential for accounting abuse under FASB’s rule change. Yet bank stocks are up 25% since Kanjorski’s hearing in March.

‘FASB’s mission is to craft rules that give investors clear, relevant financial information. Its latest proposals are nothing more than sops to the banks,’ Reilly writes. ‘If adopted, they will only confirm for investors that markets are now a rigged game.’

-- Tom Petruno