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FASB Scraps Controversial Bank Debt Rule

Critics said the rule added confusion to banks' earnings statements and distorted their financial performance.
Matthew HellerJanuary 7, 2016

The Financial Accounting Standards Board has scrapped a rule on the valuation of bank debt that critics said distorted the financial performance of banks.

The rule took effect as the financial system was starting to crumble in 2007 but banks soured on it, with JP Morgan Chase CEO Jamie Dimon calling it “one of the more ridiculous concepts that’s ever been invented in accounting.”

FASB said Tuesday it was changing the rule as part of an effort to “better meet the requirements of today’s complex economic environment.”

“Good riddance,” Mike Mayo, a banks analyst at CLSA, told the New York Times. “It gets rid of the noise that didn’t add value.”

According to the Wall Street Journal, the rule required the banks to record losses when the debt was considered safer and rose in value and to log gains when the debt was considered riskier and declined in value.

“The rationale for that odd scenario was that lower market prices make it cheaper for banks to repurchase their own debt, so the banks’ earnings should reflect the profits or losses they would get if they did so,” the WSJ explained.

But after the financial crisis, “when the value of bank debt began to gyrate, the rule became a major headache as the resulting gains and losses regularly distorted earnings by hundreds of millions of dollars or more each quarter,” the Journal said.

In the fourth quarter of 2008, for instance, when Morgan Stanley was having huge losses on its mortgage securities, it also booked $2.7 billion in fair value gains in its debt and equity trading operations that were driven by a fall in the value of the bank’s liabilities.

Under the new standard, gains and losses in the value of bank debt will be taken out of net income and put in “other comprehensive income,” a category for a variety of items that don’t stem from a bank’s operations.

The prior rule “added confusing noise to banks’ earnings statements that distracted from the fundamental performance of the banks’ businesses,” the Times said.

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