Credit Crisis: Don't Blame Accounting Rules
An international financial advisory group said on July 28 that accounting rules were not the cause of the recent credit crisis.
The Financial Crisis Advisory Group also voiced concern about recent regulatory pressure that led to the easing of guidelines about how banks value risky assets that were at the center of the crisis.
In a report released July 28, the group said "accounting standards were not a root cause of the financial crisis," but did acknowledge that the weakness in the application of rules reduced credibility in financial reporting.
Valuation Standards Debated At the heart of the debate over accounting standards is a rule determining how banks can value assets such as mortgage-backed securities. In a split vote in early April, the U.S. Financial Accounting Standards Board approved a change to the rule, allowing financial firms to value assets at what they would go for in an "orderly" sale, as opposed to a forced or distressed sale.
The two dissenting voters on the five-member board said at that time the FASB was pressured by Congress to make the change.
The advisory group said in the report that regulators should not be able to dictate specific rules that are established by two main accounting boards that oversee standards, FASB in the U.S. and the International Accounting Standards Board overseas. "While it is appropriate for public authorities to voice their concerns and give input to standard setters, in doing so they should not seek to prescribe specific standard-setting outcomes," the group wrote in the report.
Critics had contended the rule made the current financial crisis worse by forcing banks to heavily slash the value of assets such as mortgage-backed securities that were severely depressed by market conditions—conditions where the sale of those assets would only be completed at distressed prices because the market was not functioning properly.
Mark-to-Market Didn't Intensify Crisis While acknowledging that market turmoil was readily apparent through the valuing of certain assets, the advisory group said the rules governing how to value those assets—known as "mark-to-market," or fair value, accounting—did not intensify the credit crisis. "Proponents of fair value accounting do not deny that mark-to-market accounting shows the fluctuations of the market, but they maintain that these cycles are a fact of life and that the use of fair value accounting does not exacerbate these cycles," the report said.
The value of mortgage-backed securities, which are bonds backed by home loans, and other risky investment products fell sharply beginning in 2007 as the housing market deteriorated and the economy faltered. Banks were required, because of the accounting rules, to record hundreds of billions of dollars in noncash charges to reflect the waning value of those investments sitting on their balance sheets.
As their value fell, banks became more reluctant to sell the assets at a loss, only further weakening their prices and leading to more writedowns. Only recently have writedowns begun to slow. An estimated $2 trillion in soured assets is sitting on banks' books.
Easing or even eliminating that rule, as some industry groups and politicians have proposed, could remove transparency for investors, warned the advisory group that is co-chaired by Harvey Goldschmid, a former commissioner of the U.S. Securities & Exchange Commission, and Hans Hoogervorst, chairman of the Netherlands Authority for the Financial Markets.