Accounting fix could pave way for U.S. "bad bank"

WASHINGTON Fri Jan 30, 2009 8:16pm GMT

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WASHINGTON (Reuters) - A selective suspension of fair value accounting is one idea being floated as U.S. policymakers wrestle with how to price bad assets the government might buy from the distressed banking industry.

The accounting fix suggested by a bank industry group could prevent banks from having to broadly mark down all assets to the prices a government-run "bad bank" might pay.

The Obama administration is discussing setting up a government-run "bad bank" that could soak up mortgage securities and other distressed investments that have become virtually impossible to sell in the markets.

But pricing remains a thorny issue.

If the government values the assets too high, the taxpayer would be unduly burdened. If they are priced too low, an accounting tsunami would be set off as other banks are forced to write down assets on their own books.

Scott Talbott, chief of government affairs for the Financial Services Roundtable, said the U.S. Securities and Exchange Commission could send a letter to the industry, informing banks that sales involving the bad bank do not constitute a market price for accounting purposes.

"Otherwise it could trigger losses that all banks have to pick up, which is exactly opposite of what the government is trying to do," Talbott told Reuters.

There is precedent for bank-specific accounting fixes.

In October, the SEC and Financial Accounting Standards Board (FASB) sent a letter saying banks could treat warrants as permanent equity instead of liabilities in certain circumstances.

It cleared the way for banks to participate in the Treasury Department's $250 billion (172.8 billion pound) capital injection plan, in which banks received federal cash in exchange for preferred shares and warrants.

Asked whether the SEC would be willing to amend aspects of fair value accounting, an agency spokesman indicated the agency was not closed to improving aspects of the requirement also known as mark-to-market accounting.

"While the SEC does not recommend suspending existing fair value standards, our recent report to Congress makes several recommendations to improve fair value's application, including a reassessment by FASB of current impairment accounting models for financial instruments," the spokesman told Reuters.

The Obama administration has not yet consulted the SEC on fair value accounting changes, according to a source familiar with the communication between the two groups.

Accounting tweaks were also used during the savings and loan crisis in the 1980s.

Regulators encouraged investors and healthy institutions to take over failing thrifts by changing an accounting rule related to acquisitions to let buyers circumvent normal capital requirements. The change was later reversed.

Mark-to-market accounting rules have been a hot topic of discussion in recent months, as they have been blamed by some U.S. banks and lawmakers for billions of dollars in write-downs.

Fair value accounting took full effect last year in the United States and was designed to let investors truly see what is on the balance sheet and to help them understand which assets are under stress.

It requires assets such as mortgage-backed securities to be valued at market prices, but the rules have been difficult to apply in current market conditions when there is little to no market for such assets.

And the financial industry worries government purchases of illiquid assets could only amplify fair value accounting's damaging effects.

"There is concern that if the government buys massive amounts of this stuff, you reinforce the markdowns and you kind of lock them in, and banks are sitting with massive capital losses," said Bert Ely, a banking industry consultant in Alexandria, Virginia.

However, proponents of fair value accounting say temporarily suspending the rules for transactions involving a government-run bad bank would only temporarily suspend the truth of what assets are worth.

"When accounting diverges from economic reality, that's where you run into problems," said Hal Schroeder, director of relative value arbitrage at Carlson Capital.

(Reporting by Karey Wutkowski and Rachelle Younglai; Editing by Tim Dobbyn)

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