Key change in accounting may boost banks' balance sheets

How to price depressed loans and securities has been a hot topic during recent congressional hearings. At a March 12 hearing before the Senate Budget Committee, Treasury Secretary Timothy Geithner expressed reservations about some of the proposed changes. “My personal view is we have to be very careful not to do things that would erode confidence in the people’s ability to assess the risks in exposure to a bank,” he stated. “There are some versions of those proposals that would have that risk.”

Federal Reserve Chairman Ben Bernanke, in a Feb. 25 hearing before the House Financial Services Committee, called the mark-to-market issue “a very difficult question.” In principle, he said, it is good for firms to be valued as accurately as possible. “You know it’s good for investor confidence that they think they’re seeing the true value of the underlying ... firm,” he said.

But, he added, “it is absolutely the case that under certain circumstances, when you have markets where the asset is not traded or is very thinly traded, it's very difficult to use market information to judge what the appropriate value is. And that makes the mark-to-market approach very difficult to execute in a sensible way.”

On Thursday, the stock market, which had been anticipating the change, reacted in a very positive fashion. As of about 2:30 p.m. Thursday, the Dow Jones Industrial Average was up almost 290 points. The FASB decision was one factor in the market rally, says Scott Brown, chief economist at Raymond James & Associates in St. Petersburg, Fla. “But the FASB news had been rumored for a while,” he notes.

Although the stock market reacted well to the announcement, some investors expressed some skepticism.

“My thought is that rigging the scale does not mean you have lost weight,” says Doug Roberts, director of research at Channel Capital Research in Shrewsbury, N.J. “This is kind of a temporary fix, but you still have to know what these things [the illiquid assets] are worth.”

Even though one of the results of the move may be to bolster the balance sheets of the banks, the change could make the banks look less attractive as investments, some analysts argue.

“If we water down financial America’s accounting rules so we no longer have balance sheets we can believe in, if we water down the accounting rules to let companies declare the values they want, what does that do to investor confidence?” asks Espen Robak, president of Pluris Valuation Advisors, a New York company that values illiquid assets. “You will want to know what it is they are not telling you, and that will make you much more cautious about buying stocks.”

The Chartered Financial Analyst Institute (CFA), in a letter to FASB, was even more blunt. The move, it said, means “the capital markets will remain closed to major banks and other financial intermediaries for an extended period of time and a higher cost of capital imposed.” It continued, “Investors will not be willing to commit capital to firms that hide the economic value of their assets and liabilities. Reduced capital access will restrict the ability of the banks to diversify their funding sources and slow the recovery process.”

At its press conference, FASB said it valued the input from the CFA. But Robert Herz, FASB chairman, said it reached out to many groups, including mutual funds, hedge funds, and the rating agencies, “and the majority supported what we were doing.”

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