Congress has embraced an idea to help prop up the financial system: Give banks a break by letting them value their bad mortgage assets at a price they could fetch later, not now.
Lawmakers want the Securities and Exchange Commission to implement the idea as part of the $700 billion financial bailout package. But critics fear that might only postpone the reckoning for banks — and taxpayers.
Since 2007, the banks have had to value their mortgage-related assets at current market prices, a form of accounting called "fair market value," or the snappier "mark to market."
The board that governs accounting principles imposed the rule out of concern that companies had misled investors for years about the true value of their assets.
Devastated by the write-downs they have been forced to take on mortgage assets since the collapse of the housing market, banks are pushing hard for a change. They say today's hammered prices shouldn't set the long-term value of their assets.
But critics, including analysts and advocates for investors, say such a change would be dangerous.
"Financial statements would essentially lose all meaning," says Octavio Marenzi, head of consulting firm Celent.
The American Bankers Association said in a letter to the SEC that current accounting standards "never anticipated the wide variance and price disconnects that we are experiencing today."
Backing the banks, William Isaac, a former chairman of the Federal Deposit Insurance Corp., criticized what he called the SEC's refusal so far "to abandon its very destructive approach of forcing banks to take excessive and unjustified write-downs on their assets."
The rescue bill before Congress would allow the SEC to suspend the "mark to market" rule. The SEC hasn't yet gone that far on its own. But it did say Tuesday that it was clarifying existing rules in a way that gives banks more flexibility to set higher values for assets that might be worth more in the future if there's no market for them today. That means banks wouldn't have to take so many write-downs of assets and could post higher earnings.
For banks, more liberal accounting rules carry an even bigger benefit: time for the economy to recover. Once it does, demand for the assets will improve, allowing for more accurate pricing, said Matthew Warren, an associate director of equity research at Morningstar.
The Financial Accounting Standards Board implemented the stricter accounting requirements in November out of concern that companies had misled investors for years about the value of their assets.
Investor advocates say scrapping the rule now would encourage exactly the kind of shady accounting that defined the Enron era earlier this decade.
"It's a real serious concern," said Barbara Roper, director of investor protection at the Consumer Federation of America.
Besides, when the real estate market was soaring a few years ago and mortgage asset values were spiking, no banks complained about having to use mark-to-market accounting, noted Edward Ketz, an associate professor of accounting at Pennsylvania State University.
Independent accountants also are lobbying against the change.
"In our view, investor confidence would be undermined by efforts designed to mask the actual value of financial assets at a given point in time," Cynthia Fornelli, executive director of the Center for Audit Quality, a policy group backed by the largest accounting firms, wrote in a letter Tuesday to members of Congress.
Citigroup could be a big beneficiary of the change, noted Anton Schutz, portfolio manager of Burnham Financial Funds. Citi has raised more than $40 billion to bolster a balance sheet hit hard by the mortgage crisis, and adjusting the accounting rules would provide an even bigger cushion, he added.
Isaac, the former FDIC chairman, remains a leading voice for easing the rule. The write-downs have already made banks tighten the lending that keeps the economy humming, he said.
Federal Reserve Chairman Ben Bernanke has lent his support, too. As part of the bailout, Bernanke has suggested the government could buy banks' bad assets at a "hold-to-maturity" price, based on estimates of what the securities would eventually be worth as payments came in over the years.
"Banks will have a basis for valuing those assets and will not have to use fire-sale prices," Bernanke said. "Their capital will not be unreasonably marked down."