Barney Frank to FASB: Quit pretending to so much reality and certainty in fair value accounting!

by Kurt Schulzke on March 12, 2009

Today, in congressional action sure to give every internal auditor and financial analyst recurring nightmares, members of the U.S. House Capital Markets Subcommittee demanded that the Financial Accounting Standards Board (FASB) demonstrate greater flexibility and speed in changing market-to-market (or “fair value”) accounting rules in the face of today’s financial industry crisis, or else. Much of the commentary came across as a congressional call for an IASB-like principles approach in place of the FASB’s detailed rules-based approach.

House Financial Services Committee Chair Barney Frank (D-Mass) and Capital Markets Subcommittee Chair Paul Kanjorski (D-Pa), each in his own way, stated that mark-to-market accounting must be applied differently to different companies and industries based on their respective circumstances that changed must happen now, not later after more “academic” study. In his opening statement, Kanjorski declared:

We meet today to examine the much publicized and hotly debated mark-to-market accounting rules. . . Previously, I have taken the position that the Congress should not interfere through legislation in the area of establishing specific accounting rules. It seemed best that such technical work be left to the regulators, standard setters, and financial experts.

We can, however, no longer deny the reality of the pro-cyclical nature of mark-to-market accounting. It . . . has exacerbated the ongoing economic crisis. If the regulators and standard setters do not act now to improve the standards, then the Congress will have no other option than to act itself.

To say that the Congress will have to act is not to advocate an outright suspension of mark-to-market accounting. If we do away with this standard entirely, accounting will revert to the very kind of subjectivity and sleight-of-hand that made mark-to-market necessary in the first place. The standard does provide transparency for investors, but its strict application in the current environment is, in too many instances, distorting, rather than clarifying, the picture. . .

As our witnesses explain the implications of this standard and offer solutions to improve its application, we must bear in mind that fair value accounting is not one uniform rule affecting all parties to whom it applies in the same manner. . .

Moreover, one industry’s predicament may require a unique accounting treatment or regulatory forbearance that will not solve another sector’s problems. In pursuing improvements, we need to recognize this fact. . .

Frank, as well, made some remarkable statements — some of which will create consternation in the accounting community — in his opening. Among other things, Frank suggested that write-downs of banks’ asset portfolios should be tied to the particular bank’s level of culpability for the decline in asset value:

We do have to have you move now. It is important that we get some speed. . . You are the FASB . . . cannot be the “slowsb”.  First, more realism and flexibility in the mark-to-market . . . Yes, we had irrational exuberance . . . but this is not the time to make up for past mistakes by excessive rigidity . . . by pretending that there is more reality and certainty in mark-to-market than there is. It should be applied with flexibility . . .

It does seem to me that if you are talking about an asset class that [has traditionally been held to maturity] and is performing and it is providing an income stream, that the case for devaluing that is a lot weaker . . . I do not think we have had enough flexibility in how we apply them.

Second, we need to give you some discretion in how you apply, how you react to these things. I am now asking everybody . . . if anything in existing legislation deprives you of discretion, in how you react in a mark-down-to-market situation, I insist that you tell us. That’s our job. Our job is to think about the extent to which we give you some discretion.

There is no point in having these things be so automatic. It does seem to me . . . if the institution, if a bank, has to mark down its assets, why it had to do that is something you take into account. If they did it because they made a lot of stupid decisions, that’s one thing. If they had to do it because of things that happened in the economy over which they had no control, over assets that are still performing, that’s another. Consequences of a write-down should not be identical in very different situations. . . .

In the context of Frank’s remarks, I can imagine consumers asking, “What about me?” Why, if banks should be treated with so much flexibility, should consumers not be given similar consideration by credit card companies and mortgage lenders who now base their credit limits and interest rates entirely on sterile mathematical formulas that fail utterly to account for the reasons why a particular borrower is financially underwater?

You can watch today’s hearing on video on CSPAN. Witness and committee members’ statements are accessible at the Financial Services Committee website.