The Securities and Exchange Commission is considering suspending “fair value” accounting rules, which have a major impact on the way financial institutions count some of their assets, including the mortgage-backed securities at the heart of the current financial crisis.
The $700 billion rescue plan signed into law by President Bush Oct. 3 gave the SEC the authority to pursue such measures.
That move has stirred hot debate among leading financial services industry executives and lobbyists.
The American Bankers Association and Financial Services Roundtable, for example, have expressed support for relaxing or suspending the accounting standard.
But the head of the Financial Accounting Foundation, several chief executives of the Big Four accounting firms and former SEC chairman Arthur Levitt all warned against interfering with the rules.
“Fair value” accounting requires certain financial companies to write down (or up) the value of certain assets to their current market value, or the price they would bring in if they were put on the open market.
Late last month the SEC granted companies more leeway in determining the value of their assets. But some in Congress and the industry want the SEC to go further and suspend fair value rules.
Opponents of the rule claim that it is exacerbating the current financial crisis by forcing banks to post massive write-downs of their mortgage-backed securities, which have lost most of their value on the open market.
“Hysteria has occurred in the marketplace,” said Kenneth Goldmann, partner and capital markets and SEC practice director at J.H. Cohn, a New Jersey-based audit, tax and accounting firm. “The mentality is that mortgage-backed securities are worthless, so no one wants to purchase them. That has led to an implosion of their market value.”
As banks and other financial institutions write down their assets, some have been forced by regulators to raise capital to meet minimum capital standards.
That creates another problem because “raising capital means banks will have less money to lend,” adding to the severity of the credit crunch, said Leslie Grodd, a CPA and attorney at the Hartford law firm Halloran & Sage.
“It has caused companies, larger banks especially, to lose a lot of value in their portfolios,” Grodd said.
Markdowns have also eroded investor confidence, spurring stock sell-offs.
Proponents of the rule, which is also known as mark-to-market accounting, say it’s needed for transparency purposes. By reporting assets at their current value, financial institutions are more accurately reflecting how they are performing, Grodd said.
“It’s important for investors and the public to know the actual worth of a company’s holdings,” Grodd said. “It’s a good idea to give people as much information as possible.”
Dennis Nally, chairman and senior partner at Pricewaterhouse Coopers, a Big Four accounting firm with operations in Hartford, wrote a letter to Congress urging them not to suspend the rule. He said other countries that attempted to do so during tough economic times regretted the decision later.
“The nearly decade-long Japanese economic malaise that began in the 1990s as a result of Japan’s own credit crisis can be attributed in part to a Japanese banking sector that failed to reflect the real value of its assets,” Nally wrote in his Oct. 1 letter. “Not only did the lack of transparency contribute to Japan’s stagnant economic performance, it undermined the credibility of the banking sector years after the crisis took place.”
On the other hand, John Allison, chairman and CEO of BB&T, a well-capitalized North Carolina bank holding company with assets of $136 billion, said in a Sept. 23 letter to Congress, “Fair value accounting should be changed immediately. If we had fair value accounting, as interpreted today, in the early 1990s the United States financial system would have crashed. Accounting should not drive economic activity, it should reflect it.”
If the rule were to be suspended there is also a question of what would replace it. That has added to the uncertainty of the situation.
Goldmann said both sides have valid arguments, but he doesn’t think the SEC should suspend the rule.
“To eliminate it completely is to really put our head in the sand,” he said.
