Politicizing Accounting -- No End to the Scams

Dave Lindorff

The accounting profession might seem like the last place that you'd find serious political hanky-panky going on, and it's probably not on very many people's A-list of fun subjects to read about. The Financial Accounting Standards Board (FASB), a quasi-governmental body that has statutory authority to regulate and establish the rules by which public companies, including banks, do their books, has just caved in to pressure from those banks and from the large number of members of Congress who pocket huge piles of campaign swag and perks from those banks and other public companies, and gravely undermined the integrity of corporate balance sheets.

This may sound incredibly arcane, but what the FASB has done is declare that assets held by companies (including banks) on their books will no longer have to be valued at their current market value. Under new guidelines, effective retroactively to March 15, these assets can now be valued at what the corporate managers think (or pretend to think) they will be worth at some time in the future when they might try to sell them.

Think about it for a minute. Say you own a house, which you might have bought 10 years ago for $200,000, using a $180,000 mortgage. Today, depending on where you live in the country, that house might be worth as little as $100,000. If you still owe $100,000 on your mortgage, that would give you a net worth of 0 (a lot more than what Citibank and Bank of America are worth today). Now let's say you want to go out and buy a $20,000 car on credit. The auto dealer, before extending you a car loan, will want to know what your net worth is. Under market-to-market accounting rules, you would have to say that your net worth is 0, and you probably wouldn't get a loan -- especially if your employment, like that of many Americans, is iffy, and you're carrying a big balance on your credit cards. But under the new FASB guidelines, if you were to be treated like a bank, you could estimate the value of your house as $200,000 (the price you paid for it), or perhaps even $250,000 (the price you "expect" it to get when you decide to sell it). You have no real way of knowing whether your house will ever return to being worth $200,000. For all you know, it could fall further over the next five years to $75,000 or $50,000, but that doesn't matter. You, the owner, are saying that your "reasonable expectation" is that this asset of yours is "worth" $200,000. And bingo, thanks to the magic of modern FASB-approved accounting, your net worth, instead of being 0, is now $100,000. You can buy your car.

This is what the FASB is now saying banks and other companies can do.

If you are an investor, or a potential investor, you now have to be very wary. After all, how are you to establish what a company is really worth, if the management is able to play games with the value of its assets? The answer is you really can't know. Things get much worse when it comes specifically to banks, which after all, are all about the assets.

Remember those "toxic" assets -- the alphabet soup of debt products with initials such as CDO, CDS, SIV, all composed of diced and sliced debt that for the most part is close to worthless? Well, thanks to the FASB's accommodating change in the rules, instead of valuing those debt holdings (remember, loans are assets to a bank) at what they are worth on the market today, the banks are now able to value them at what they supposedly think they will be worth at some future date when the bank might want to sell them. This is a wholly fictional figure, of course. Nobody knows what, if anything, these crap debt instruments are going to be worth, but it's a fair bet that most of them won't be worth any more a decade hence than they are worth today (and maybe less). But who cares? The important thing is that now the banks, who have huge black holes in their balance sheets, can now fill those holes with artificially inflated assets and make themselves look a whole lot better financially than they really are.

There's an irony here. The big banks that hold most of the toxic debt (and especially the five largest banks that hold 96% of the garbage) desperately wanted this FASB rule change because they wanted to prettify their balance sheet in hopes of boosting their share values and of maintaining the pretense that they are not zombies. But in doing this, they are undermining a key goal of the Obama Administration and of Treasury Secretary Tim Geithner and Federal Reserve Chair Ben Bernanke, who wanted to have the government and private investors start buying those trillions of dollars' worth of toxic assets off of the banks' hands.

Remember, if the banks declare that the toxic assets on their books are worth some fictitious amount, they have to sell them at that price, or stand accused of faking their books, i.e., fraud. But investors, such as hedge funds and other institutional investors, are not going to want to buy those assets at anything but distressed bargain-basement prices, because even with the government assuming 92 percent of the risk, they are not going to buy these trash assets unless they see the chance for a significant upside.

So with the new rule, the banks will end up being stuck holding the very toxic assets that have sent them into a tailspin in the first place.

The vote to end market-to-market accounting rules was controversial even on the five-member FASB board, which ended up narrowly voting 3-2 in favor of the measure. One member who voted against the change, Thomas Linsmeier, decried what he said was "pressure" on the board to act. A House committee had threatened to introduce legislation that would force the change if the FASB didn't act on its own.

The US budget has long been a work of fiction. Now the books of the nation's banks and of many of its public companies will also be pure works of fiction.

As columnist Jonathan Weil wrote in Bloomberg.com last month as the FASB was considering making this change in its rules, "The FASB ought to change its name to the Fraudulent Accounting Standards Board."

The road to ruin, it turns out, is not paved with good intentions after all. It is paved by powerful lobbyists buying short-term benefits at the public's expense.

By the way, if you think Citigroup is solvent, I have a great deal on a house for you.

DAVE LINDORFF is a journalist based in Philadelphia. His latest book is "The Case for Impeachment" (St. Martin's Press, 2006). His work is available at www.thiscantbehappening.net.

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