Accounting rule-makers on Thursday did all they could to make the nation's credit nightmare go away -- or at least go back into the closet -- sending stocks higher.
The Financial Accounting Standards Board, under heavy pressure from politicians and financial firms, will let companies use "significant" judgment in valuing some assets, notably mortgage securities, rather than relying on current illiquid market prices.
FASB OK'd changes that will also boost capital on battered bank balance sheets.
Big U.S. banks are expected to get a Q1 earnings lift of 20% or more from the new rules.
The major averages also climbed on FASB and optimism about the global economy. The S&P 500 rose 2.9% and the Nasdaq 3.3%.
Many on Wall Street say strict mark-to-market rules have led to huge write-downs on assets, forcing banks to raise more capital and exacerbating the financial crisis.
FASB's new rules let banks use their own models to value assets in thinly-traded markets. Mark-to-model valuations, which can use cash flow from pooled mortgage loans, are expected to be higher than mark-to-market prices.
Critics say this will let banks hide their dirty laundry, making balance sheets less transparent and investors more wary.
Also, large banks may now have more incentive to keep mortgage-backed securities on their books rather than sell them to investors under the Treasury's planned $1 trillion private-public program, say observers.
FASB also approved rule changes that reduce the amount of impairment losses recognized in earnings. Companies will be allowed to split credit losses from noncredit losses.
If companies plan to hold assets until they mature or housing markets recover, a charge would only result in the event of a credit loss.
FASB says credit losses would be based on cash-flow models impaired by loan defaults or foreclosures.
"The big (changes) are measuring the value of assets and what goes to earnings versus what goes to unrealized losses," said Jay Hanson, national director of accounting at McGladrey & Pullen. "Of the two, the more significant change is what goes to earnings. That provides a lot of relief to mark-to-market rules."
Banks and other companies will be able to apply the new rules to Q1 results. Banks report in late April. The rules are mandatory for the June quarter.
Big Profit Boost
"The magnitude of impact on profits could be substantial for financial institutions if OTTI (other-than-temporary impairment) charges are taken out," said Dietrich. "It could be anywhere from 20% to 100%."
FASB proposed accounting rule changes on March 17, after lawmakers made it clear that Congress would act if FASB didn't. The private-sector body sets bookkeeping rules that are enforced by the Securities and Exchange Commission.
The SEC released a study in late 2008 that stated so-called "fair value" accounting rules didn't play a meaningful role in bank failures last year. It recommended that fair-value accounting rules not be suspended as some lawmakers have demanded.
But the agency, along with other policymakers, signaled a willingness to modify rules in recent weeks.
"For Congress to pressure accounting standard-setters puts us on a dangerous path and highlights the power of the bank lobby," said Joshua Rosner, managing director of consulting firm Graham Fisher & Co.
The CFA Institute, which represents investor groups, objects to the FASB's new rules.
"The net result of a disorderly retreat from the application of objective principles of fair value accounting is that the capital markets will remain closed to major banks," wrote Kurt Schacht, managing director of the CFA's Center for financial market integrity, in a letter to FASB's board.
"Investors will not be willing to commit capital to firms that hide the economic value of their assets and liabilities," Schacht stated.
Banks have argued that mark-to-market rules, just two years old, don't work as intended during a financial crisis when companies are forced to dump assets at fire-sale prices or can't sell assets in thinly traded markets.
Whether banks hold enough capital against potential write-downs has been a big issue. Hanson says the FASB changes aid banks.
"There's going to be a cumulative catch-up adjustment for all the previous temporary impairment charges that have been taken," he said.
Banks won't restate earnings for past quarters, Hanson says. But, they'll be able to reclassify parts of previous losses in retained earnings that were not credit-related.
"The big deal is that it restores part of regulatory capital," he said.
Not So Toxic?
Treasury Secretary Timothy Geithner unveiled the Public-Private Investment Program on March 23. The government will provide loans to private investors that agree to buy mortgage-backed securities to rid bank balance sheets of toxic assets.
But banks may not want to sell.
"In a perverse way, this (FASB) accounting change may discourage banks from selling assets," said Dietrich. "By selling, they have to take a loss (depleting capital). There's an incentive working against the direction of the Treasury, which wants them to sell."
Joe Bartlett, attorney at Sullivan & Worcester, says that banks will have more leverage.
"Banks, at least some of them, will be able to say: 'We no longer need to sell these assets. We now have the ability to mark them up to what we consider realistic valuations. Accordingly, if you want to take them off our hands, you have to bid higher'," Bartlett said. The law firm's clients include private equity groups, hedge funds and banks.
Rosner doesn't think big banks will get off that easy.
"I believe that many (banks) will be compelled to sell by regulators," he said. "For those who aren't compelled and have properly marked (values), PPIP will, because of the debt guarantees and leverage, allow buyers to pay them a premium over market price.
"That will allow them to take a gain upon the sale. For those who aren't compelled (to sell) and are mismarking (values) there are several reasons -- including hits to book -- so the proposed FASB changes may reduce their willingness to sell."
Source: Investor's Business Daily