VideoPolitics are creeping into accounting once again. This time it's through a proposed law that would replace the Securites and Exchange Commission as the sole overseer of accounting standards, and turn that role over to a high-level group that would let bank regulators have a say in approving accounting rules.
The bill, which would sharply widen the government's oversight over how accounting rules are applied, was introduced Friday. Under HR 1349 — the Federal Accounting Oversight Board Act — the SEC would cede its accounting-oversight powers to a newly created board. According to the bill, drafted by Colorado Democrat Ed Perlmutter and Oklahoma Republican Frank Lucas, the FAOB would comprise five top regulators: the Secretary of the Treasury, the chairman of the Federal Reserve, the chairman of the SEC, the chairman of the Federal Deposit Insurance Corp., and the chairman of the Public Company Accounting Oversight Board.
Currently, the Financial Accounting Standards Board operates under the aegis of the SEC, which has budget approval power over FASB as the main U.S. accounting standard setting organization. In addition, the SEC has the ability to nominate and interview trustees of the Financial Accounting Foundation, FASB's parent, and the organization that nominates and approves the five FASB members. Under the arrangement proposed in the bill, FASB would remain, but would be under the new FAOB instead of the SEC.
Regulatory reform, including accounting rule revisions, has been a theme in Washington of late. Today, in a speech to the Council on Foreign Relations, Fed chairman Ben Bernanke called for a review of accounting rules that affect the way companies value assets, according to a report in the New York Times. However, the report noted that Bernanke said he did not support suspending fair-value accounting rules. Later this week, members of a House subcommittee are scheduled to discuss the merits of the Perlmutter-Lucas bill during a hearing on the financial crisis.
Code for Tampering with Fair Value
The new bill would stipulate that when approving accounting rules, the FAOB must consider, among other things, how standards create systemic risk exposure to the American public, financial markets, and global financial markets. The board must also make sure that accounting rules "handle illiquid and liquid assets differently."
Further, the bill states that if another federal financial regulatory agency determines that an accounting rule "has an adverse effect on the safety and soundness of the entities [it regulates], the health of the United States financial system, or the economy, [it] may request authorization from the FAOB to review such standard." What's more, the FAOB would have the power to determine whether the rule should continue to be applied or be removed on either a temporary or permanent basis, which could strip FASB of its rulemaking and rule revising role.
These provisions seem to be code for tampering with fair-value accounting rules, which critics have blamed for exacerbating the current credit crisis. Indeed, fair-value accounting forced companies to take huge writedowns on the value of some financial instruments that were exposed to risks associated with the subprime meltdown. However, many investor groups say that fair-value accounting helped reflect the true economic value of the instruments, and in many cases helped to expose risky investments sooner.
However, the architects of HR 1349 contend that the proposed law, which also includes an expansion of government oversight to include a broader view of the economy, gives "FASB the tools it needs" to be flexible enough to respond to changes in the markets, says Leslie Oliver, a spokesperson for Perlmutter.
An Echo of the Bankers' Views
According to a statement released by Perlmutter's office, the bill would give regulators greater ability to judge the value of assets being held to maturity. "Arbitrarily decreasing capital levels of financial institutions puts our communities at risk by causing some financial institutions to show an artificial undercapitalization which prevents them from lending money to business and individuals," said Perlmutter in the statement.
That view of accounting, and more specifically fair-value accounting, has been echoed by bankers since the credit crisis went into overdrive last year. For example, in April 2008, during the debate over whether fair value accounting should be applied to financial instruments that are held to maturity, American Bankers Association president and CEO Edward Yingling characterized mark-to-market accounting in illiquid markets as "pouring gasoline on the fire."
Yingling pointed out that fair value accounting is appropriate for financial instruments that are held for trading purposes. However, for assets and liabilities that are not based around short-term trading, or are held to maturity - such as loans, deposits, and receivables - fair-value measurement leads to income statement volatility (understatements and overstatements), according to both the ABA and its international counterpart, the International Banking Federation.
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