Untangling the financial crises

Mar 14, 2009
In The News


One of the problems bedeviling the banking industry might be fixed without throwing billions of dollars at it, so it seems rather amazing that a months-long debate over the matter has continued without a solution.

The problem results from applying a federal accounting regulation to the banking system that, while meant to protect investors during normal times, twists a garrote around the necks of banks in the throes of a financial crisis.

So we’re pleased to see a bipartisan bill in Congress introduced by Colorado Congressman Ed Perlmutter meant to tackle the issue.

Perlmutter, the Golden Democrat, has introduced House Resolution 1349 with Republican Congressman Frank Lucas of Oklahoma. It would assemble the chairmen of a handful of financial regulators and task them with immediately examining whether the regulatory standard should be changed. Among other things, the board would evaluate whether accounting principles should "apply to distressed markets differently than well-functioning markets."

Though in theory the Security and Exchange Commission and the independent Financial Accounting Standards Board could retool the accounting standard without help from a new panel, banks have waited in vain while trying to balance their books under flush-year accounting standards. Write-downs imposed by the standard, meanwhile, have created losses in the hundreds of billions of dollars.

The threat of congressional action alone might prove enough to make the FASB and SEC act, and if the matter ended there, Perlmutter and Lucas would have accomplished plenty. But even if the problem solves itself, we think debating the merits of HR 1349 is worthwhile.

The FASB sets generally accepted accounting principles for financial industries that the SEC enforces. To protect the FASB from political meddling, the law prevents Congress from setting standards on its own.

An accounting standard known both as "fair-value" and "mark-to-market" requires banks to value their assets at market prices, even if the banks don’t intend to sell assets while they remain undervalued.

The result is that a bank’s books may look undercapitalized even if its assets are fundamentally sound, which then prevents banks from making loans — all of which leads to frozen credit markets. Warren Buffett and others have suggested that regulators be allowed to apply a different standard during an emergency — one that doesn’t, in Buffett’s words, force banks "to put a lot more capital in based on these mark-to-market figures."

Perlmutter’s idea is to bring the leadership of the Board of Governors of the Federal Reserve System, the SEC, the Federal Deposit Insurance Corporation, the Public Accounting Oversight Board, as well as the secretary of Treasury together to discuss other accounting regulation options. The board would then make recommendations to the FASB.

In a future crisis, HR 1349 would allow for a more immediate gathering, which could prevent months of dithering while markets plunge.

Matters dealing with such complexities as exist in the financial marketplace are never easy, but Perlmutter’s solution ought to be considered.

Meanwhile, the SEC and the FASB ought to act on their own.

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