Danger: Banks Politicize Accounting

Anyone who cares about the reliability of corporate financial information in the US—and everyone should—ought to oppose threatend Congressional action that would expressly politicize accounting standard setting.   Since the 1930s, accounting standards in the US have been set by a private, independent, non-political body called, since the mid-1970s, the Financial Accounting Standards Board (pronounced faz-bee).

Corporate America often hates what FASB requires—on subjects ranging, over the years, from accounting for pensions, mergers, stock options, and, today, financial instruments. It plies friends in Congress to push back against FASB when stakes are high enough. Sometimes that means FASB fights for its life.  (For a scholarly take on this, see Bill Bratton’s insightful BC Law Review piece here.)

An example: in the late 1990s, corporate America got Senator Joe Lieberman to threaten to preempt FASB if it required corporate America to account for stock options—a threat FASB heeded until after that period’s financial frauds restored its insulation from political pressure. (Since, FASB has required corporate America to account for stock options as an expense.  Then-SEC Chair Arthur Levitt recounts the story in his memoir Take on the Street.)

Banks are today’s most vehement proponents of turning accounting standards into political products—detesting FASB’s accounting standards concerning off-balance sheet financing, securitizations, and, especially, measuring financial instruments at fair value.  Banks want to politicize accounting standards because they are extremely good at influencing politicians, but have essentially no power to manipulate FASB directly.  One reason is Washington’s revolving door—banks have teams of lobbyists who formerly worked there, on the Hill or in agencies.

As usual, though, the banking lobby’s arguments are so weak that it should be difficult for all but the crassest politician to accept them. A terrific example appears in an open letter in circulation courtesy of Forbes magazine from a former banking regulator (an FDIC Chair) cum global financial advisor, William Isaac.

The letter begins with these unsupported assertions: (1) “there is no question that [FASB] was a major contributor to the financial panic of 2008” and (2) “Mark-to-market (MTM) accounting senselessly destroyed over $500 billion of capital in our financial system, panicking the markets. . . .” The letter adds ad hominem invective, twice accusing FASB of operating in an “ivory tower” divorced from reality.

That invective is obviously hogwash; more seriously, not only does the letter fail to offer any support for its two sweeping opening assertions, they are unsupportable in fact and are contradicted by several serious empirical studies, including one by the Federal Reserve’s own researcher (Sanders Shaffer) and two others by prominent scholars (one by Laux & Leuz and one by Badertscher, Burks & Easton).   Shaffer’s conclusion is representative of this growing body of research that Isaac’s screed ignores:

Based on this simple analysis it would appear that fair value accounting had a minimal impact on the capital of most banks in the sample during the crisis period through the end of 2008.  Capital destruction was due to deterioration in loan portfolios and was further depleted by items such as proprietary trading losses and common stock dividends. These are a result of lending practices and the actions of bank management, not accounting rules.

Banks are trying to use their considerable political influence to expand it to encompass accounting standards.   Allowing that would be a grave mistake.  Fortunately, their arguments are so weak, backers may not prevail.  But anyone with a voice and interest should let their Congress people know.

Hat Tip: Lynn Turner

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2 Responses

  1. Scot B. says:

    Perhaps my memory is fuzzy; wasn’t it Congress who insisted on mark-to-market accounting after Enron demonstrated that mark-to-model was a sophisticated way of living on Fantasy Island?

    Also, if violating FASB guidelines gets a company into legal trouble with the SEC, doesn’t that give Congress a valid reason to care what FASB policy is?

  2. Scot may be thinking of noted Corporate America stooge Democratic congressman Kanjorski demands in 2009 that FASB change its mark-to-market approach (and indeed that first bullet by Isaac merely echoes Kanjorski and others).

    Or perhaps he is thinking of Barney Frank from just a few months ago as he was shilling for the Banks (which no doubt also helps keep the spotlight off his role with Fannie and Freddie and the whole mortgage mess)

    …and it’s not just “corporate” America; I recall Labor America being vocally aghast at changes in pension accounting just a few years ago.

    But all this shouldn’t be a problem anyway because, even if Congress does give in to the banks, surely CO hero Barack Obama will will step in and do the right thing with a veto…right?