Revenge of the Accounting Authorities?

The Financial Accounting Standards Board took plenty of heat in April for loosening mark-to-market guidelines, a move that critics assailed as a gift to the financial industry and a nod to political pressures.

The FASB's latest idea, however, if seen to completion, would go a long way toward silencing accusations that the rulemakers have gone soft on banks.

Under consideration: an unprecedented proposal to vastly widen the use of mark-to-market accounting, so that it becomes the default method for valuing financial instruments, including loans that banks plan to hold to maturity. If adopted, the rule could set off a new wave of writedowns at a time when investor confidence in banks is fragile at best.

Proponents say that stricter use of mark-to-market would simplify accounting rules and give investors a clearer picture of companies' financial health. The opposition, led by the bank lobby, says it is unfair to make companies absorb the blow of falling market values for loans they have no intention of selling. And they say that new questions would be raised as to how to value specialty loans and other assets for which there are no ready markets.

Debate on the issue has been relatively muted because the FASB has not yet initiated its formal process for considering new rules. But a July board meeting gave observers the most detailed look yet at the ideas being floated, and the topic is on the agenda again for a FASB meeting scheduled for Thursday, when a formal proposal may get hammered out.

The American Bankers Association is trying a nip-it-in-the-bud approach, publishing a position paper earlier this month and sending a letter to accounting standards-setters in advance of an official public comment period.

"What they're discussing now would be the biggest accounting change we've ever seen," said Donna Fisher, the ABA's senior vice president of tax, accounting and financial management. "If you wait too long, then everybody is wed to their positions, so we really need to start early."

The desire to redraw the rules on valuations predates the financial crisis, with the FASB and its counterparts at the International Accounting Standards Board discussing the topic at two joint meetings in 2005. But the crisis heaped new attention on the issue, with the mark-to-market methodology currently in use alternatively criticized as a dangerous catalyst for the financial system's disarray or a convenient scapegoat for it.

In April, the FASB issued new guidance on determining whether a market is active, and increased the flexibility companies have for valuing illiquid assets. At the same time, the board allowed banks to separate credit writedowns from market writedowns when accounting for other-than-temporary impairments to assets, requiring that only the credit portion of the loss be subtracted from earnings.

That action, which critics of the FASB took as a sign that the board had caved in to pressure from financial industry lobbyists and their allies in Congress, sought to answer some of the questions about when and how mark-to-market valuations ought to be applied. The latest proposal would seek to clear up the "when" question, with companies potentially instructed to use mark-to-market for nearly every financial asset on the books. But questions about how to apply valuations remain.

"If the FASB is going to move to requiring that every instrument be marked at market value, it's going to require a lot more specific guidance for companies and auditors as to what to use for the market value in different situations," said Brian Bushee, an accounting professor at the University of Pennsylvania's Wharton School. "Most companies might not be opposed to [using] market value if they had confidence that a true market value was showing up on the balance sheet."

The FASB, which referred questions about the thinking behind its latest proposal to a fact sheet posted on its Web site, appears to be taking a harder line than international accounting standard-setters, who issued a different set of proposals after deliberating separately on the topic. The IASB, which is trying to develop global standards that may eventually converge with U.S. standards, would let companies eschew mark-to-market for basic loans that would be held to maturity.

Marking loans to market under the blanket rule being considered by the FASB would be especially tough for banks that traffic in agricultural loans and other niche products for which no organized market exists, said Ann Grochala, vice president of lending and accounting policy at the Independent Community Bankers of America.

"FASB appears to think they've moved forward enough with valuation methodology that it shouldn't be a problem anymore. We'd beg to differ," she said.

Most community banks do not use mark-to-market when given the option, but they must apply it to their investment portfolios. The new FASB proposal certainly would simplify the preparer's approach, allowing for a single methodology for all kinds of assets, but Grochala questioned whether that would produce a clearer snapshot of a company's health.

"Continuing to use an accounting basis that's more difficult is better than switching to something that's going to give a significantly less accurate picture and add much more volatility to your valuations for organizations that are not buying and selling their balance sheet items on a daily basis," she said.

Bushee, the accounting professor, suggested two potential compromises that might make the proposal more palatable for the industry. First, have downward marks kick in only after prices have been depressed for a set amount of time, say six or 12 months. Second, have regulators base bank capital requirements on numbers that are less subject to the vagaries of the market.

"There are multiple constituencies here, where investors and regulators may want different types of information, and we may want different rules to facilitate that," he said.