The politics of accounting and bank failure

Over the holiday period, the Washington Post put out a piece entitled: Accounting Standards Wilt Under Pressure. The nub of the piece is that political finagling put US banks in a bind on the ‘mark to market’ issue such that the SEC felt compelled to cave into the banks demands that they operate internal methods of valuation, rather than the stricter asset valuation rules then in place.

I’m aware Francine McKenna is digging around the detail on this but a couple of points are worth picking up:

For years, there has been a disconnect between U.S. and international accounting rules. With the history of corporate litigation in the United States, U.S. standards tend to be exact and explicit, making it easier for companies to defend themselves in court.

That may be so but it also works the other way as the number of prosecutions for fraud show. Whenever there are strict rules, you’ll always find some joker willing to find ways to work around. I’d argue that the stricter the rule (and therefore the more narrowly defined) the easier it is to argue minutiae of detail to circumvent the intended impact.

Of course poorly worded rules lead to amendment after amendment with the unintended but inevitable complexity and muddying that follows. Even so, the profession comes off looking pretty shabby because in effect, WashPo is accusing the EU of exerting undue political influence on IASB, putting its back against the wall. Hang on. Is that correct?

The changes FASB were being asked to consider and which IASB is claimed to have been coerced into foisting upon the US were a direct result of the US banks having a problem with which they could not live. It was OK at other times when the likes of Lehman’s CEO were siphoning off $480 million, but not now? So where was the pressure coming from? The banks of course.

This from FinancialWeek on 24th December

“I was particularly frustrated discussing with banking regulators their apparent unwillingness to consider changes to regulatory capital based upon disclosures that we might consider putting into financial statements,” said Mr. Smith [FASB], noting that the regulators instead peg their regulatory capital to accounting standards that FASB has in place right now. “It seems to me they have it in their wherewithal to do something other than that.”

A spokeswoman for the Federal Reserve, the lead bank regulator, failed to respond to a request for comment. A spokesman for the SEC, which oversees FASB, declined comment.

While FASB took into account the views of investors, banks and others, the views of regulators are widely considered more influential in this case, since the banking industry is under intense pressure to raise more capital at a time when more lending is expected to help ease the recession.

“The board was under tremendous political pressure” to ease its rules, said Pat Finnegan, director of financial reporting policy for the CFA Institute Centre for Financial Market Integrity.

Pot, kettle, black methinks.But then we’ve seen plenty of finger waving in the last few months. To me, this is the clearest picture yet of how the profession has ended up squeezed on both sides and shown itself incapable of mustering the muscle or protection to do the right thing.

Much more important though are underlying principles that are not articulated in either of the posts. Just who the heck is running the profession? We know FASB is financed by the profession in the US but it seems the SEC can over-ride or ignore it when it is under pressure from the Fed. In other words it is the Fed that’s setting the rules and not the profession nor the oversight authorities when conditions suit the Fed. Is that right?

If the crippled banking system is to be brought back to good health there has to be a fundamental rethink about where power really lays in the setting of and upholding of standards. It cannot be acceptable under any regime for private agencies – the Fed is NOT a government body – to dictate what is in what amounts to its best, private interests alone. It is a perpetuation of this ludicrous and dangerous state of affairs that faces the incoming US president which has a knock on effect around the world.

And while we’re at it, let’s balance what the Fed was trying to do against a recent assessment of the Fed’s own balance sheet manoevures. It is really scary stuff. (See the above graph of ballooning assets, check the other graphs in the report.)

Which only leaves three questions:

1. Does anyone have a clue what the heck is going on? And if so would they care to enlighten the rest of us and perhaps indulge us with an honest assessment of the risks?
2. Has the US profession been so neutered that a funded regulator not only has difficulty getting cooperation out of the very people it’s supposed to oversee but can equally be pushed around by those against which it is supposed to be shielded?
3. What are the long term implications for meaningful regulation of any kind in a so-called global economy?
   

If the answer to 1. is ‘no’ and 2. is ‘yes’ and 3. is ‘don’t know’ then we are in much deeper trouble than any of us realize. We just haven’t seen the fat lady come on stage to sing the final tune.

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Tagged as: Federal Reserve System, Financial Accounting Standards Board, Francine McKenna, International Accounting Standards Board, Washington Post