Bloomberg wrote: March 30 (Bloomberg) -- Four days after U.S. lawmakers berated Financial Accounting Standards Board Chairman Robert Herz and threatened to take rulemaking out of his hands, FASB proposed an overhaul of fair-value accounting that may improve profits at banks such as Citigroup Inc. by more than 20 percent.
The changes proposed on March 16 to fair-value, also known as mark-to-market accounting, would allow companies to use “significant judgment” in valuing assets and reduce the amount of writedowns they must take on so-called impaired investments, including mortgage-backed securities. A final vote on the resolutions, which would apply to first-quarter financial statements, is scheduled for April 2.
FASB’s acquiescence followed lobbying efforts by the U.S. Chamber of Commerce, the American Bankers Association and companies ranging from Bank of New York Mellon Corp., the world’s largest custodian of financial assets, to community lender Brentwood Bank in Pennsylvania. Former regulators and accounting analysts say the new rules would hurt investors who need more transparency, not less, in financial statements.
Officials at Norwalk, Connecticut-based FASB were under “tremendous pressure” and “more or less eviscerated mark-to- market accounting,” said Robert Willens, a former managing director at Lehman Brothers Holdings Inc. who runs his own tax and accounting advisory firm in New York. “I’d say there was a pretty close cause and effect.”
Willens, investor-advocate groups including the CFA Institute in Charlottesville, Virginia, and former U.S. Securities and Exchange Commission Chairman Arthur Levitt oppose changes that would enable banks to put off reporting losses.
‘Outrageous Threats’
“What disturbs me most about the FASB action is they appear to be bowing to outrageous threats from members of Congress who are beholden to corporate supporters,” said Levitt, now a senior adviser at buyout firm Carlyle Group and a board member at Bloomberg LP, the parent of Bloomberg News.
FASB spokesman Neal McGarity said the proposal allowing significant judgment was “in the works prior to the Washington hearing and was merely accelerated for the first quarter, instead of the second quarter.” The plan on impaired investments “was an attempt to address an important financial reporting issue that has emerged from the financial crisis,” he said.
Mary Schapiro, sworn in as SEC chairman in January, testified to Congress on March 11 that the agency recommends “more judgment in the application, so that assets are not being written down to fire-sale prices.”
Unrealized Losses
Goldman Sachs Group Inc. investment strategist Abby Joseph Cohen and Nouriel Roubini, the New York University professor who predicted last year’s economic crisis, made bearish forecasts last week about the outlook for the banking industry. Cohen says banks aren’t yet “in the clear,” and Roubini expects the government to nationalize more lenders as the economy contracts. The 24-member KBW Bank Index rose 21 percent in March, after slumping 75 percent during the prior 12 months.
By letting banks use internal models instead of market prices and allowing them to take into account the cash flow of securities, FASB’s change could boost bank industry earnings by 20 percent, Willens said. Companies weighed down by mortgage- backed securities, such as New York-based Citigroup, could cut their losses by 50 percent to 70 percent, said Richard Dietrich, an accounting professor at Ohio State University in Columbus.
“This could turn net losses into significant net gains,” Dietrich said. “It may well swing the difference as to whether bank earnings are strong this quarter, or flat to negative.”
‘Unintended Consequences’
Citigroup had $1.6 billion of losses last year for so- called Alt-A mortgages, according to the company’s annual report. That loss would be erased with the new FASB rules, Dietrich said.
Bank of America Corp. in Charlotte, North Carolina, reported “income before income taxes” last year of $4.4 billion. The FASB proposal on impaired securities would increase that figure by about $3.5 billion, or the amount of “other- than-temporary” losses that the company recognized, Dietrich said. The new rule would mean the loss would be stripped out of net income, boosting earnings, though it would still be reported in financial statements.
“We’re studying the proposals,” Bank of America spokesman Scott Silvestri said. Citigroup spokesman Michael Hanretta declined to comment.
While helping lenders report higher earnings, FASB’s changes may hurt Treasury Secretary Timothy Geithner’s plan to remove distressed assets from bank balance sheets, Dietrich said. Allowing companies to hold on to assets without writing them down could discourage them from selling the securities, which would work against Treasury’s objective to resuscitate markets, he said.
“It’s one of the unintended consequences of having the FASB bow to political pressure,” Dietrich said.
Bank Lobbying
Fair-value requires companies to set values on most securities each quarter based on market prices. Banks argue that the rule doesn’t make sense when trading has dried up because it forces them to write down assets to less than they’re worth.
“Mark-to-market is fundamentally not about a quote on a screen,” Richard Kovacevich, chairman of San Francisco-based Wells Fargo & Co., said in a March 13 speech.
Conrad Hewitt, a former chief accountant at the SEC who stepped down in January, said representatives from the ABA, American International Group Inc., Fannie Mae and Freddie Mac all lobbied him over the past two years to suspend the fair- value rule.
Executives “would come to me in the afternoon with the argument, ‘You’ve got to suspend it,’” Hewitt said in a March 25 interview. The SEC, which oversees FASB, would reject their demands, and “the next morning their lobbyists would go to Congress,” he said.
‘Is That Fair?’
AIG’s near-collapse in September prompted a $182.5 billion government rescue of what was once the world’s largest insurer. Earlier that month, the Federal Housing Finance Agency put Fannie Mae and Freddie Mac under its control after the worst housing slump since the Great Depression threatened the survival of the mortgage-finance companies.
Banks and insurers wanted to value securities at prices they bought them for, Hewitt said. His response: “If you carry them at 100 percent of what your purchase price was and they are worth 50 percent, is that fair to the investor?”
Hewitt said nothing the SEC and FASB did curtailed the lobbying by financial companies, including issuing guidelines on how to price assets when no market exists and conducting a congressionally mandated study of fair-value accounting.
“I don’t think there was anything that would have pacified them,” short of a suspension, he said.
Bank of New York
Efforts to change accounting rules continued after the election of President Barack Obama. Bank of New York Chief Executive Officer Robert Kelly spoke with Gary Gensler, a Treasury official during the Clinton administration who was asked by the transition team to evaluate the SEC. Kelly said in an interview that while he opposes suspending mark-to-market accounting, he discussed with Gensler ways to lessen its impact. Gensler, who has since been nominated to chair the Commodity Futures Trading Commission, declined to comment.
Bank of New York would be one of the biggest beneficiaries of FASB’s proposed changes, said Jeff Davis, director of research at Chicago-based brokerage Howe Barnes Hoefer & Arnett. The company’s earnings were reduced by $1.6 billion last year from writedowns for mortgage-backed securities, according to its annual report. The bank, which said it expects to ultimately lose about $535 million on the assets, blamed the disparity on “market illiquidity.”
House Hearing
At a March 12 hearing of a House Financial Services subcommittee, lawmakers showed impatience with FASB.
“You do understand the message that we’re sending?” panel chairman Paul Kanjorski, a Pennsylvania Democrat, asked Herz.
“Yes, I absolutely do, sir,” Herz replied.
After hesitating, Herz said he would try to get a new fair- value rule finished within three weeks.
“The financial institutions and their trade groups have been lobbying heavily,” Herz said in an interview after the hearing. “Investors don’t lobby heavily.”
The political action committees of banks including Citigroup, Bank of America, Bank of New York Mellon, Wells Fargo and banking trade groups contributed money to Kanjorski’s re- election campaign last year, according to the Federal Election Commission. Citigroup gave $6,500, Bank of America $7,000, Bank of New York $8,000 and Wells Fargo $13,000.
Kanjorski spokeswoman Abigail McDonough didn’t return calls seeking comment.
Atlanta Lender
Three days before the hearing, 31 financial-industry groups sent a letter to committee chairman Barney Frank and Alabama Representative Spencer Bachus, the panel’s ranking Republican, emphasizing “the need to correct the unintended consequences of mark-to-market accounting.” The organizations included the ABA, the National Association of Realtors and the 12 Federal Home Loan banks, the government-chartered cooperatives owned by U.S. financial companies.
The Federal Home Loan Bank of Atlanta, which Kanjorski cited at his hearing as an institution hurt by fair-value accounting, would also stand to gain from FASB’s proposals.
The company, one of 12 regional institutions that provide low-cost financing to 8,000 member banks, absorbed an $87.3 million writedown on three mortgage-backed securities after determining it would not collect all the cash the assets were supposed to generate, according to a November SEC filing.
Under the FASB proposal, the reduction in the bank’s earnings would be much closer to the $44,000 that the company expects to lose, according to Brian Harris, a senior vice president at Moody’s Investors Service in New York.
‘Raging Inferno’
“It potentially moves the accounting closer to where we saw the economics of these transactions,” Harris said in a March 24 interview. “We don’t see a risk to their debt securities.”
Also endorsing the letter was the Pennsylvania Association of Community Bankers. Thomas Bailey, the group’s chairman and CEO of Brentwood Bank in Bethel Park, Pennsylvania, told the subcommittee that using fair-value accounting “in these times, is much like throwing gasoline on a raging inferno.”
Among the banks most negatively affected by unrealized losses are Wells Fargo, PNC Financial Services Group Inc. in Pittsburgh, Minneapolis-based U.S. Bancorp and M&T Bank Corp. in Buffalo, Robert W. Baird & Co. analyst David George wrote in a March 20 note to clients.
FASB’s proposals, he wrote, would “potentially provide cover for some banks that might otherwise need to raise government capital.”
Levitt wrote:Confidence, trust, and numbers that investors can believe in are the stuff that make or break the capital markets. When investors question the validity of numbers, they sell and wait, rather than buy and invest.
This Story
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Weakening A Market Watchdog
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The Toxic Assets We Elected
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Optimism Over Despair
Yet those charged with building confidence and trust and presenting numbers that can be believed are under sustained attack -- and they are losing. Over the past few weeks, banks and their supporters in Congress have applied significant pressure on the Financial Accounting Standards Board (FASB) to rewrite standards for valuing distressed assets on bank balance sheets.
Earlier this month, Robert Herz, chairman of the FASB, was lectured by members of the House Financial Services Committee. "Don't make us tell you what to do," said Rep. Randy Neugebauer (R-Tex.). "Just do it. Just get it done." Said Rep. Gary L. Ackerman (D-N.Y.): "If you don't act, we will."
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This is like being forced to give your boss several mulligans in a round of golf. And so last week, the FASB voted to propose allowing banks to obscure -- some might say bury -- the full extent of impairments on many of the bad loans and investments they made and securitized over the past few years. These impairments have traditionally been valued at market prices (thus, the phrase "mark-to-market"), so that investors can know what the banks would stand to lose if those investments were sold today.
The FASB's proposal goes against what we know investors prefer: Stronger rules for the reporting of changes in the values of investments in income statements. Under the proposed rule, no matter how toxic the investment, whether it's a penny stock or the bonds of a government ward such as AIG, companies can choose to largely ignore the fundamental reasons behind the investments' decline. All that companies have to do is say they don't intend to sell those investments until their value rebounds.
Such a subjective judgment is bound to decrease investor confidence in reported income. And in a strange twist of fate, the FASB's proposals may create even greater opportunities for short sellers who are adept at digging into numbers that do not tell the whole story.
Yet the real scandal here is not the decision by the FASB -- with which I strongly disagree but which others might be able to defend. Rather, it is how the independence of regulators and standard-setters is being threatened. This isn't just about the income statements of banks. It's about further eroding investor confidence, precisely at a moment when investors are practically screaming for more protection.
The FASB was created to stand apart from partisanship and momentary shifts in public opinion precisely because the value of accounting standards comes in the consistency of their application over time and circumstance. Chairman Herz acquiesced, it appears, in order to keep Congress from invading FASB turf. Yet in seeking to protect its independence, the board has surrendered some of it in the bargain.
Every regulatory agency should take note: Independence from public pressure has a value, and when you give some of it away, you've lost something that takes years to rebuild. Just ask the Federal Reserve, which lost its reputation for independence from political pressure in the early 1970s and didn't regain it for a decade.
In the past, the FASB has made significant changes to its rules only after significant due process, including comment periods that often lasted for three months and a full discussion reflecting those public comments. The rule change agreed to by the FASB on Tuesday followed only one public meeting on this topic, and the board is giving investors just two weeks to comment, with a final vote the next day. This is a rush job.
The FASB should rethink its approach to these rules. The board should develop new standards providing investors with improved disclosures regarding the quality of banks' assets. More information is needed on the ratings the banks and regulators place on their loans. And above all, the Securities and Exchange Commission should take a firm stand on the side of investors and vigorously resist all political efforts to reduce the independence of financial rule-making agencies and boards.
Investors once believed that U.S. markets were sufficiently protected from political pressure and manipulation by a system of interlocking independent agencies and rule-making bodies -- some government-run, some not. That system is being dismantled, piece by piece, by political jawboning and rushed rule rewrites. Now, investors find themselves with fewer protections and weakened protectors.
