Hey, Sheila Bair, What's Wrong With Accounting Anarchy?

One thing that has long escaped me has been the point of battles over accounting standards. In particular, I don’t understand why regulators get into arguments with the accounting standards boards over mark-to-market accounting.

FDIC Chairwoman Sheila Bair on CNBC'c Power Lunch
FDIC Chairwoman Sheila Bair on CNBC'c Power Lunch

This morning Sheila Bair, speaking at a SIFMA conference, outlined the objections regulators have to proposals to adopt mark to market—otherwise known as “fair value”—accounting standards for financial instruments. Here’s what Bair said:

Another ongoing regulatory process is FASB's proposal to substantially revise the accounting standards for financial instruments. Under the proposed rule, banks would be required to measure substantially all of their financial instruments at fair value on the balance sheet.

While we understand that the objective of the rule is to make financial statements more transparent, we believe that its effect could be to undermine financial stability by making bank performance more procyclical. In short, we do not believe that a bank—whose business strategy is to hold loans and deposit liabilities for the long term—should be required to measure them at fair value on the balance sheet. Why? Because fair value does not necessarily reflect the manner in which the cash flows associated with these instruments will be realized or expended.

In September, the five federal bank regulatory agencies submitted a joint comment letter to FASB outlining our opposition to fair-value measurement. Instead, we support the continued use of amortized cost—subject to a robust asset impairment model—for financial instruments when the bank's business strategy is to hold them for the collection or payment of regular cash flows. We do agree that some instruments with highly variable cash flows, such as derivatives and marketable equity investments, should be subject to fair value accounting.

We also support enhanced supplemental disclosure of fair-value information that will give investors and others a more informed view of the institution. But, as outlined in our joint comment letter, we believe that there are a number of other approaches that could enhance the reporting of forward-looking information by banks without imposing an accounting model on them that is inappropriate for their business.

Here’s what I don’t get: why do we need one set of accounting standards at all? To put it differently, why should banking regulators feel obliged to judge the safety and soundness of financial institutions according to any measure that they do not like? If Bair doesn’t think fair value is appropriate to the banking sector, can’t she just ignore fair value when judging whether banks satisfy regulatory requirements?

What’s the harm in letting shareholders know the fair value of financial instruments held by banks? Is it the fear that investors will react irrationally? It seems to me that during the financial crisis of 2008, it was the lack of information that induced panic rather than the supply. Do the regulators think keeping investors in the dark about the fair value of the balance sheets of banks will produce investor confidence?

My truly radical proposal is that we should probably do away with this argument altogether by allowing banks—and every other company for that matter—to choose which accounting standards they want to use. If amortized cost is truly a better standard, banks using that will surely be rewarded by higher stock prices and cheaper access to credit. On the other hand, if fair value is appropriate, the market will reward that. Why not let banks choose and bear the costs of their choice?


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