"Mark to Market" Eliminated for "Toxic Assets"

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Wall Street Journal – 2 April 2009

FASB Eases Mark-to-Market Rules
By KARA SCANNELL

U.S. accounting rule makers made it easier for banks to limit losses, but in an unexpected move they bowed to critics and backtracked on one proposal that would have let companies ignore market prices in some cases.

The vote by the Financial Accounting Standards Board followed a debate in which members of Congress pushed for steps to help banks weighed down by troubled assets, while some investor groups warned that the plans would allow executives to cover up losses. The rules change spurred Thursday's stock-market rally.

For the most part, the board ratified proposals it had put out for comment two weeks earlier, including changes that would lessen the need for banks to take an earnings hit when assets run into trouble. Financial stocks led the market up in the morning on the expectation that the rules would be approved, but faded and ended roughly on a par with the broader market.

Bankers argue that the "mark-to-market" principle of valuing assets at market prices is sometimes flawed because markets have ceased to function. They say that can lead to unnecessary alarm about the financial system's stability, an argument lawmakers have echoed.

One member of the five-member accounting standards board tried to address criticisms that the body had bowed to political pressure.

"We are an independent standard setter and it's important that we maintain our independence," said Lawrence Smith. But he said the board can't "ignore what's going on around us" as banks plead for help.

Under one of the changes adopted Thursday, the definition of an asset that is "other than temporarily impaired" will change. Once an asset gets that designation, it triggers a write-down in value that feeds through to the bottom line. In the case of banks, that may put capital below regulatory requirements.

Currently, to avoid the designation, management must assert that it has the intent and ability to hold on to the asset until its value recovers. Under the new rule, adopted by a 3-2 vote, companies could avoid the classification by stating that they intend to hold on to the asset and that it is more likely than not that they will, a looser standard.

Patrick Finnegan, director of financial reporting policy for the CFA Institute, said the move gives managers too much room to fudge the truth. "Financial statements are not there to reflect management's assumptions.," said Mr. Finnegan, whose group runs a self-study program for financial analysts.

The new rule draws a distinction that is especially relevant to mortgage-backed securities. The market for these securities has largely dried up, but banks say that most homeowners still are making mortgage payments.

The rule says that once an asset is other than temporarily impaired, only losses related to the underlying creditworthiness would affect earnings and regulatory capital. Losses attributed to market conditions would be disclosed and accounted for elsewhere.

Business groups mostly commended the changes, but said they aren't enough. "Significant problems remain with asset valuations, and guidance is needed for auditors," the U.S. Chamber of Commerce said in a statement.

Some investors were relieved that FASB backtracked from one of its proposals, which would have allowed companies to ignore all market prices when coming up with a value for securities once a market was determined to be inactive.

FASB instead said that more weight should be placed on transactions when a market is operating in an orderly fashion and less when the market is less active.

Write to Kara Scannell at kara.scannell@wsj.com